Localiza Rent a Car's (BVMF:RENT3) Sluggish Earnings Might Be Just The Beginning Of Its Problems

A lackluster earnings announcement from Localiza Rent a Car S.A. (BVMF:RENT3) last week didn't sink the stock price. However, we believe that investors should be aware of some underlying factors which may be of concern.

View our latest analysis for Localiza Rent a Car

Zooming In On Localiza Rent a Car's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to December 2023, Localiza Rent a Car had an accrual ratio of 0.23. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Even though it reported a profit of R$1.81b, a look at free cash flow indicates it actually burnt through R$10b in the last year. We also note that Localiza Rent a Car's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of R$10b. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. Localiza Rent a Car expanded the number of shares on issue by 8.1% over the last year. Therefore, each share now receives a smaller portion of profit. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out Localiza Rent a Car's historical EPS growth by clicking on this link.

How Is Dilution Impacting Localiza Rent a Car's Earnings Per Share (EPS)?

Localiza Rent a Car has improved its profit over the last three years, with an annualized gain of 72% in that time. In comparison, earnings per share only gained 27% over the same period. Net income was down 2.1% over the last twelve months. Unfortunately for shareholders, though, the earnings per share result was even worse, declining 17%. So you can see that the dilution has had a bit of an impact on shareholders.

In the long term, if Localiza Rent a Car's earnings per share can increase, then the share price should too. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

Our Take On Localiza Rent a Car's Profit Performance

As it turns out, Localiza Rent a Car couldn't match its profit with cashflow and its dilution means that shareholders own less of the company than the did before (unless they bought more shares). Considering all this we'd argue Localiza Rent a Car's profits probably give an overly generous impression of its sustainable level of profitability. So while earnings quality is important, it's equally important to consider the risks facing Localiza Rent a Car at this point in time. To help with this, we've discovered 5 warning signs (2 make us uncomfortable!) that you ought to be aware of before buying any shares in Localiza Rent a Car.

Our examination of Localiza Rent a Car has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.