Ero Copper's (TSE:ERO) Problems Go Beyond Poor Profit

The recent earnings release from Ero Copper Corp. (TSE:ERO ) was disappointing to investors. We think there is more to the story than simply soft profit numbers. Our analysis shows that there are some other factors of concern.

Check out our latest analysis for Ero Copper

Examining Cashflow Against Ero Copper'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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to December 2023, Ero Copper recorded an accrual ratio of 0.44. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of US$298m despite its profit of US$92.8m, mentioned above. We also note that Ero Copper's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of US$298m. Unfortunately for shareholders, the company has also been issuing new shares, diluting 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.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. In fact, Ero Copper increased the number of shares on issue by 11% over the last twelve months by issuing new shares. As a result, its net income is now split between a greater number of shares. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. Check out Ero Copper's historical EPS growth by clicking on this link.

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

Ero Copper has improved its profit over the last three years, with an annualized gain of 80% in that time. In comparison, earnings per share only gained 65% over the same period. Net income was down 8.9% over the last twelve months. But the EPS result was even worse, with the company recording a decline of 12%. So you can see that the dilution has had a bit of an impact on shareholders.

If Ero Copper's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. 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 Ero Copper's Profit Performance

As it turns out, Ero Copper 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). For the reasons mentioned above, we think that a perfunctory glance at Ero Copper's statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into Ero Copper, you'd also look into what risks it is currently facing. Every company has risks, and we've spotted 2 warning signs for Ero Copper (of which 1 is significant!) you should know about.

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. 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.

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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.