Here's Why We Think Naphtha Israel Petroleum's (TLV:NFTA) Statutory Earnings Might Be Conservative

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Naphtha Israel Petroleum's (TLV:NFTA) statutory profits are a good guide to its underlying earnings.

We like the fact that Naphtha Israel Petroleum made a profit of ₪158.3m on its revenue of ₪1.75b, in the last year. Below, you can see that both its revenue and its profit have fallen over the last three years.

View our latest analysis for Naphtha Israel Petroleum

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. As a result, today we're going to take a closer look at Naphtha Israel Petroleum's cashflow, and unusual items, with a view to understanding what these might tell us about its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Naphtha Israel Petroleum.

Zooming In On Naphtha Israel Petroleum's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. 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.

Naphtha Israel Petroleum has an accrual ratio of -0.23 for the year to September 2020. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of ₪1.3b in the last year, which was a lot more than its statutory profit of ₪158.3m. Naphtha Israel Petroleum did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

How Do Unusual Items Influence Profit?

Naphtha Israel Petroleum's profit was reduced by unusual items worth ₪208m 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 that's hardly a surprise given these line items are considered unusual. Assuming those unusual expenses don't come up again, we'd therefore expect Naphtha Israel Petroleum to produce a higher profit next year, all else being equal.

Our Take On Naphtha Israel Petroleum's Profit Performance

Considering both Naphtha Israel Petroleum's accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. After considering all this, we reckon Naphtha Israel Petroleum's statutory profit probably understates its earnings potential! If you want to do dive deeper into Naphtha Israel Petroleum, you'd also look into what risks it is currently facing. Case in point: We've spotted 2 warning signs for Naphtha Israel Petroleum you should be aware of.

Our examination of Naphtha Israel Petroleum 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. 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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