We Think That There Are More Issues For Cipher Pharmaceuticals (TSE:CPH) Than Just Sluggish Earnings

Investors weren't pleased with the recent soft earnings report from Cipher Pharmaceuticals Inc. (TSE:CPH). Our analysis suggests that while the headline numbers were soft, there are some positive factors which shareholders may have missed.

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A Closer Look At Cipher Pharmaceuticals' 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. 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. 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. 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 March 2025, Cipher Pharmaceuticals recorded an accrual ratio of 0.81. 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. Even though it reported a profit of US$9.25m, a look at free cash flow indicates it actually burnt through US$59m in the last year. It's worth noting that Cipher Pharmaceuticals generated positive FCF of US$14m a year ago, so at least they've done it in the past. 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.

View our latest analysis for Cipher Pharmaceuticals

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.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. Cipher Pharmaceuticals expanded the number of shares on issue by 6.2% over the last year. Therefore, each share now receives a smaller portion of profit. 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 Cipher Pharmaceuticals' EPS by clicking here.

How Is Dilution Impacting Cipher Pharmaceuticals' Earnings Per Share (EPS)?

Cipher Pharmaceuticals has improved its profit over the last three years, with an annualized gain of 7.9% in that time. Net income was down 59% over the last twelve months. But the EPS result was even worse, with the company recording a decline of 60%. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, if Cipher Pharmaceuticals' 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 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

Unfortunately (in the short term) Cipher Pharmaceuticals saw its profit reduced by unusual items worth US$2.7m. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. 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. If Cipher Pharmaceuticals doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Cipher Pharmaceuticals' Profit Performance

In conclusion, Cipher Pharmaceuticals' accrual ratio suggests that its statutory earnings are not backed by cash flow; but the fact unusual items actually weighed on profit may create upside if those unusual items to not recur. On top of that, the dilution means that shareholders now own less of the company. After taking into account all the aforementioned observations we think that Cipher Pharmaceuticals' profits probably give a generous impression of its sustainable level of profitability. So while earnings quality is important, it's equally important to consider the risks facing Cipher Pharmaceuticals at this point in time. To that end, you should learn about the 2 warning signs we've spotted with Cipher Pharmaceuticals (including 1 which is a bit concerning).

Our examination of Cipher Pharmaceuticals 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. 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 with significant insider holdings 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.