We Think Shareholders Should Be Aware Of Some Factors Beyond Lavipharm's (ATH:LAVI) Profit

The latest earnings release from Lavipharm S.A. (ATH:LAVI ) disappointed investors. We did some digging and found some underlying numbers that are worrying.

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A Closer Look At Lavipharm'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.

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. 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.

Lavipharm has an accrual ratio of 0.22 for the year to December 2024. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Over the last year it actually had negative free cash flow of €5.0m, in contrast to the aforementioned profit of €8.67m. We also note that Lavipharm's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of €5.0m. However, as we will discuss below, we can see that the company's accrual ratio has been impacted by its tax situation. This would certainly have contributed to the weak cash conversion.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Lavipharm .

An Unusual Tax Situation

In addition to the notable accrual ratio, we can see that Lavipharm received a tax benefit of €5.1m. This is meaningful because companies usually pay tax rather than receive tax benefits. Of course, prima facie it's great to receive a tax benefit. However, the devil in the detail is that these kind of benefits only impact in the year they are booked, and are often one-off in nature. Assuming the tax benefit is not repeated every year, we could see its profitability drop noticeably, all else being equal. So while we think it's great to receive a tax benefit, it does tend to imply an increased risk that the statutory profit overstates the sustainable earnings power of the business.

Our Take On Lavipharm's Profit Performance

This year, Lavipharm couldn't match its profit with cashflow. If the tax benefit is not repeated, then profit would drop next year, all else being equal. Considering all this we'd argue Lavipharm's profits probably give an overly generous impression of its sustainable level of profitability. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Case in point: We've spotted 1 warning sign for Lavipharm you should be aware of.

Our examination of Lavipharm 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 is always more to discover if you are capable of focussing your mind on minutiae. 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 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.