Totally's (LON:TLY) Promising Earnings May Rest On Soft Foundations

Totally plc's (LON:TLY) robust earnings report didn't manage to move the market for its stock. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.

View our latest analysis for Totally

Examining Cashflow Against Totally'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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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. 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 September 2021, Totally recorded an accrual ratio of -0.35. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of UK£7.9m, well over the UK£1.16m it reported in profit. Totally'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

Surprisingly, given Totally's accrual ratio implied strong cash conversion, its paper profit was actually boosted by UK£656k in unusual items. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. 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, after all, that's exactly what the accounting terminology implies. Totally had a rather significant contribution from unusual items relative to its profit to September 2021. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

An Unusual Tax Situation

Moving on from the accrual ratio, we note that Totally profited from a tax benefit which contributed UK£239k to profit. It's always a bit noteworthy when a company is paid by the tax man, rather than paying the tax man. Of course, prima facie it's great to receive a tax benefit. And given that it lost money last year, it seems possible that the benefit is evidence that it now expects to find value in its 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. In the likely event the tax benefit is not repeated, we'd expect to see its statutory profit levels drop, at least in the absence of strong growth. 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 Totally's Profit Performance

Summing up, Totally's accrual ratio suggests that its statutory earnings are well matched by free cash flow while its unusual items and tax benefit is boosted profit in a way that may not be sustained. After taking into account all the aforementioned observations we think that Totally's profits probably give a generous impression of its sustainable level of profitability. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Every company has risks, and we've spotted 3 warning signs for Totally you should know about.

Our examination of Totally 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.

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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