Cargojet's (TSE:CJT) Conservative Accounting Might Explain Soft Earnings

The market for Cargojet Inc.'s (TSE:CJT) shares didn't move much after it posted weak earnings recently. We think that the softer headline numbers might be getting counterbalanced by some positive underlying factors.

See our latest analysis for Cargojet

A Closer Look At Cargojet'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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.

For the year to September 2024, Cargojet had an accrual ratio of -0.14. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. To wit, it produced free cash flow of CA$194m during the period, dwarfing its reported profit of CA$2.30m. Notably, Cargojet had negative free cash flow last year, so the CA$194m it produced this year was a welcome improvement. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

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.

The Impact Of Unusual Items On Profit

Surprisingly, given Cargojet's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CA$14m in unusual items. 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 crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. If Cargojet doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Cargojet's Profit Performance

Cargojet's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Given the contrasting considerations, we don't have a strong view as to whether Cargojet's profits are an apt reflection of its underlying potential for profit. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Be aware that Cargojet is showing 3 warning signs in our investment analysis and 1 of those doesn't sit too well with us...

Our examination of Cargojet has focussed on certain factors that can make its earnings look better than they are. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.