Are Mendelson Infrastructures & Industries's (TLV:MNIN) Statutory Earnings A Good Reflection Of Its Earnings Potential?

As a general rule, we think profitable companies are less risky than companies that lose money. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. Today we'll focus on whether this year's statutory profits are a good guide to understanding Mendelson Infrastructures & Industries (TLV:MNIN).

It's good to see that over the last twelve months Mendelson Infrastructures & Industries made a profit of ₪18.3m on revenue of ₪808.1m. In the last few years its profit has fallen, although its revenue was steady, as you can see in the chart below.

See our latest analysis for Mendelson Infrastructures & Industries

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. Today, we'll discuss Mendelson Infrastructures & Industries' free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Mendelson Infrastructures & Industries.

A Closer Look At Mendelson Infrastructures & 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. 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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Mendelson Infrastructures & Industries has an accrual ratio of -0.13 for the year to September 2020. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. In fact, it had free cash flow of ₪76m in the last year, which was a lot more than its statutory profit of ₪18.3m. Mendelson Infrastructures & Industries shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Mendelson Infrastructures & Industries' Profit Performance

Mendelson Infrastructures & Industries' accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that Mendelson Infrastructures & Industries' statutory profit actually understates its earnings potential! On the other hand, its EPS actually shrunk in the last twelve months. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So while earnings quality is important, it's equally important to consider the risks facing Mendelson Infrastructures & Industries at this point in time. While conducting our analysis, we found that Mendelson Infrastructures & Industries has 2 warning signs and it would be unwise to ignore these bad boys.

Today we've zoomed in on a single data point to better understand the nature of Mendelson Infrastructures & Industries' profit. 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. 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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