Africa Israel Residences (TLV:AFRE) Strong Profits May Be Masking Some Underlying Issues

Africa Israel Residences Ltd's (TLV:AFRE) healthy profit numbers didn't contain any surprises for investors. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

View our latest analysis for Africa Israel Residences

A Closer Look At Africa Israel Residences' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Africa Israel Residences has an accrual ratio of 0.20 for the year to September 2024. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In the last twelve months it actually had negative free cash flow, with an outflow of ₪415m despite its profit of ₪168.0m, mentioned above. We saw that FCF was ₪268m a year ago though, so Africa Israel Residences has at least been able to generate positive FCF in the past. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part. The good news for shareholders is that Africa Israel Residences' 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 Africa Israel Residences.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Africa Israel Residences' profit was boosted by unusual items worth ₪26m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. We can see that Africa Israel Residences' positive unusual items were quite significant relative to its profit in the year to September 2024. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Africa Israel Residences' Profit Performance

Summing up, Africa Israel Residences received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Africa Israel Residences' profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about Africa Israel Residences as a business, it's important to be aware of any risks it's facing. To that end, you should learn about the 3 warning signs we've spotted with Africa Israel Residences (including 2 which can't be ignored).

Our examination of Africa Israel Residences 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. 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 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.