We're Not Counting On Eletrobras Participações - Eletropar (BVMF:LIPR3) To Sustain Its Statutory Profitability

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. Today we'll focus on whether this year's statutory profits are a good guide to understanding Eletrobras Participações - Eletropar (BVMF:LIPR3).

While Eletrobras Participações - Eletropar was able to generate revenue of R$8.0k in the last twelve months, we think its profit result of R$32.6m was more important.

Check out our latest analysis for Eletrobras Participações - Eletropar

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. Today, we'll discuss Eletrobras Participações - Eletropar's free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Eletrobras Participações - Eletropar.

A Closer Look At Eletrobras Participações - Eletropar's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. The ratio shows us how much a company's profit exceeds its FCF.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to September 2020, Eletrobras Participações - Eletropar had an accrual ratio of 0.33. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. Indeed, in the last twelve months it reported free cash flow of R$69k, which is significantly less than its profit of R$32.6m. Eletrobras Participações - Eletropar shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. One positive for Eletrobras Participações - Eletropar shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Our Take On Eletrobras Participações - Eletropar's Profit Performance

As we discussed above, we think Eletrobras Participações - Eletropar's earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Eletrobras Participações - Eletropar's underlying earnings power is lower than its statutory profit. The good news is that it earned a profit in the last twelve months, despite its previous loss. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you want to do dive deeper into Eletrobras Participações - Eletropar, you'd also look into what risks it is currently facing. Be aware that Eletrobras Participações - Eletropar is showing 3 warning signs in our investment analysis and 2 of those are potentially serious...

This note has only looked at a single factor that sheds light on the nature of Eletrobras Participações - Eletropar's profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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This article by Simply Wall St is general in nature. 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.
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