We Think That There Are Issues Underlying Bri-Chem's (TSE:BRY) Earnings

Despite posting some strong earnings, the market for Bri-Chem Corp.'s (TSE:BRY) stock hasn't moved much. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.

View our latest analysis for Bri-Chem

Zooming In On Bri-Chem'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. 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'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Bri-Chem has an accrual ratio of 0.37 for the year to December 2021. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of CA$9.3m, in contrast to the aforementioned profit of CA$1.32m. We saw that FCF was CA$10m a year ago though, so Bri-Chem has at least been able to generate positive FCF in the past. One positive for Bri-Chem 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Bri-Chem.

Our Take On Bri-Chem's Profit Performance

As we have made quite clear, we're a bit worried that Bri-Chem didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Bri-Chem'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. So while earnings quality is important, it's equally important to consider the risks facing Bri-Chem at this point in time. Case in point: We've spotted 4 warning signs for Bri-Chem you should be mindful of and 3 of them are a bit concerning.

This note has only looked at a single factor that sheds light on the nature of Bri-Chem'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. 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.