Rank Group's (LON:RNK) Earnings May Just Be The Starting Point

The Rank Group Plc (LON:RNK) recently posted some strong earnings, and the market responded positively. We have done some analysis, and we found several positive factors beyond the profit numbers.

View our latest analysis for Rank Group

Zooming In On Rank Group'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. 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 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to December 2023, Rank Group recorded an accrual ratio of -0.13. That indicates that its free cash flow was a fair bit more than its statutory profit. Indeed, in the last twelve months it reported free cash flow of UK£56m, well over the UK£15.9m it reported in profit. Rank Group's free cash flow improved over the last year, which is generally good to see. Having said that it seems that a recent tax benefit and some unusual items have impacted its profit (and this its 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

Rank Group's profit was reduced by unusual items worth UK£23m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. 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. Rank Group took a rather significant hit from unusual items in the year to December 2023. All else being equal, this would likely have the effect of making the statutory profit look worse than its underlying earnings power.

An Unusual Tax Situation

In addition to the notable accrual ratio, we can see that Rank Group received a tax benefit of UK£19m. It's always a bit noteworthy when a company is paid by the tax man, rather than paying the tax man. The receipt of a tax benefit is obviously a good thing, on its own. And since it previously lost money, it may well simply indicate the realisation of past tax losses. However, our data indicates that tax benefits can temporarily boost statutory profit in the year it is booked, but subsequently profit may fall back. Assuming the tax benefit is not repeated every year, we could see its profitability drop noticeably, all else being equal. While we think it's good that the company has booked a tax benefit, it does mean that there's every chance the statutory profit will come in a lot higher than it would be if the income was adjusted for one-off factors.

Our Take On Rank Group's Profit Performance

Summing up, Rank Group's accrual ratio and its unusual items suggest that its statutory earnings were temporarily depressed, while its tax benefit is having the opposite effect. Looking at all these factors, we'd say that Rank Group's underlying earnings power is at least as good as the statutory numbers would make it seem. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. At Simply Wall St, we found 2 warning signs for Rank Group and we think they deserve your attention.

Our examination of Rank Group has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. But there are plenty of other ways to inform your opinion of a company. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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.

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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.