Altaley Mining's (CVE:ATLY) Earnings Aren't As Good As They Appear

The latest earnings release from Altaley Mining Corporation (CVE:ATLY ) disappointed investors. We did some digging and found some underlying numbers that are worrying.

Our analysis indicates that ATLY is potentially undervalued!

Examining Cashflow Against Altaley Mining's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. 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 2022, Altaley Mining had an accrual ratio of 0.40. 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. In the last twelve months it actually had negative free cash flow, with an outflow of CA$12m despite its profit of CA$12.8m, mentioned above. We also note that Altaley Mining's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CA$12m. However, that's not the end of the story. We can look at how unusual items in the profit and loss statement impacted its accrual ratio, as well as explore how dilution is impacting shareholders negatively.

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. As it happens, Altaley Mining issued 9.0% more new shares over the last year. That means its earnings are split among a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. You can see a chart of Altaley Mining's EPS by clicking here.

How Is Dilution Impacting Altaley Mining's Earnings Per Share (EPS)?

Altaley Mining was losing money three years ago. The good news is that profit was up 114% in the last twelve months. On the other hand, earnings per share are only up 70% over the same period. Therefore, the dilution is having a noteworthy influence on shareholder returns.

In the long term, earnings per share growth should beget share price growth. So it will certainly be a positive for shareholders if Altaley Mining can grow EPS persistently. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Altaley Mining's profit was boosted by unusual items worth CA$14m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. We can see that Altaley Mining's positive unusual items were quite significant relative to its profit in the year to September 2022. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Altaley Mining's Profit Performance

Altaley Mining didn't back up its earnings with free cashflow, but this isn't too surprising given profits were inflated by unusual items. Meanwhile, the new shares issued mean that shareholders now own less of the company, unless they tipped in more cash themselves. For all the reasons mentioned above, we think that, at a glance, Altaley Mining's statutory profits could be considered to be low quality, because they are likely to give investors an overly positive impression of the company. So while earnings quality is important, it's equally important to consider the risks facing Altaley Mining at this point in time. For example, Altaley Mining has 4 warning signs (and 2 which are a bit concerning) we think you should know about.

Our examination of Altaley Mining 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 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.