IMCO Industries' (TLV:IMCO) Solid Profits Have Weak Fundamentals

IMCO Industries Ltd. (TLV:IMCO) just reported some strong earnings, and the market rewarded them with a positive share price move. We did some analysis and think that investors are missing some details hidden beneath the profit numbers.

Check out our latest analysis for IMCO Industries

Examining Cashflow Against IMCO Industries' 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. 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.

For the year to June 2021, IMCO Industries had an accrual ratio of 0.25. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of ₪16m, in contrast to the aforementioned profit of ₪3.82m. It's worth noting that IMCO Industries generated positive FCF of ₪13m a year ago, so at least they've done it in the past. The good news for shareholders is that IMCO Industries' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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

Our Take On IMCO Industries' Profit Performance

IMCO Industries' accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that IMCO Industries' true underlying earnings power is actually less than its statutory profit. On the bright side, the company showed enough improvement to book a profit this year, after losing money last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. 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 IMCO Industries (of which 1 is significant!) you should know about.

This note has only looked at a single factor that sheds light on the nature of IMCO Industries' profit. 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.

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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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