Statutory Earnings May Not Be The Best Way To Understand Avila Energy's (CSE:VIK) True Position

Despite posting strong earnings, Avila Energy Corporation's (CSE:VIK) stock didn't move much over the last week. We looked deeper into the numbers and found that shareholders might be concerned with some underlying weaknesses.

Check out our latest analysis for Avila Energy

A Closer Look At Avila Energy's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to September 2022, Avila Energy recorded an accrual ratio of 1.70. 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. Even though it reported a profit of CA$1.65m, a look at free cash flow indicates it actually burnt through CA$38m in the last year. We also note that Avila Energy's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CA$38m. Having said that, there is more to consider. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Avila Energy.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. As it happens, Avila Energy issued 150% more new shares over the last year. That means its earnings are split among a greater number of shares. 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. You can see a chart of Avila Energy's EPS by clicking here.

A Look At The Impact Of Avila Energy's Dilution On Its Earnings Per Share (EPS)

Avila Energy was losing money three years ago. And even focusing only on the last twelve months, we don't have a meaningful growth rate because it made a loss a year ago, too. But mathematics aside, it is always good to see when a formerly unprofitable business come good (though we accept profit would have been higher if dilution had not been required). So you can see that the dilution has had a fairly significant impact on shareholders.

In the long term, if Avila Energy'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.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by CA$2.5m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. Avila Energy had a rather significant contribution from unusual items relative to its profit to September 2022. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Avila Energy's Profit Performance

In conclusion, Avila Energy's weak accrual ratio suggested its statutory earnings have been inflated by the unusual items. The dilution means the results are weaker when viewed from a per-share perspective. On reflection, the above-mentioned factors give us the strong impression that Avila Energy'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Be aware that Avila Energy is showing 4 warning signs in our investment analysis and 2 of those are concerning...

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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.