Stock Analysis

PNE (ETR:PNE3) Is Posting Solid Earnings, But It Is Not All Good News

XTRA:PNE3
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Solid profit numbers didn't seem to be enough to please PNE AG's (ETR:PNE3) shareholders. Our analysis has found some concerning factors which weaken the profit's foundation.

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earnings-and-revenue-history
XTRA:PNE3 Earnings and Revenue History November 17th 2021

Zooming In On PNE'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). 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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

PNE has an accrual ratio of 0.38 for the year to September 2021. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of €156m, in contrast to the aforementioned profit of €2.48m. We also note that PNE's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of €156m. 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.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that PNE's profit was boosted by unusual items worth €1.1m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. 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. And that's as you'd expect, given these boosts are described as 'unusual'. If PNE 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 PNE's Profit Performance

Summing up, PNE received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue PNE's profits probably give an overly generous impression of its sustainable level of profitability. So while earnings quality is important, it's equally important to consider the risks facing PNE at this point in time. Every company has risks, and we've spotted 2 warning signs for PNE 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. 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.

Valuation is complex, but we're helping make it simple.

Find out whether PNE is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.

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