Investors Shouldn't Be Too Comfortable With El Al Israel Airlines' (TLV:ELAL) Robust Earnings

El Al Israel Airlines Ltd.'s (TLV:ELAL) stock was strong after they recently reported robust earnings. However, our analysis suggests that shareholders may be missing some factors that indicate the earnings result was not as good as it looked.

Check out our latest analysis for El Al Israel Airlines

A Closer Look At El Al Israel Airlines' 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). The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

El Al Israel Airlines has an accrual ratio of -0.25 for the year to December 2022. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of US$247m during the period, dwarfing its reported profit of US$109.4m. Notably, El Al Israel Airlines had negative free cash flow last year, so the US$247m it produced this year was a welcome improvement. However, we can see that a recent tax benefit, along with unusual items, have impacted its statutory profit, and therefore its accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of El Al Israel Airlines.

The Impact Of Unusual Items On Profit

Surprisingly, given El Al Israel Airlines' accrual ratio implied strong cash conversion, its paper profit was actually boosted by US$11m in unusual items. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. Which is hardly surprising, given the name. If El Al Israel Airlines doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

An Unusual Tax Situation

In addition to the notable accrual ratio, we can see that El Al Israel Airlines received a tax benefit of US$124m. This is of course a bit out of the ordinary, given it is more common for companies to be paying tax than receiving tax benefits! We're sure the company was pleased with its tax benefit. And since it previously lost money, it may well simply indicate the realisation of past tax losses. However, our data indicates that tax benefits can temporarily boost statutory profit in the year it is booked, but subsequently profit may fall back. In the likely event the tax benefit is not repeated, we'd expect to see its statutory profit levels drop, at least in the absence of strong growth. While we think it's good that the company has booked a tax benefit, it does mean that there's every chance the statutory profit will come in a lot higher than it would be if the income was adjusted for one-off factors.

Our Take On El Al Israel Airlines' Profit Performance

In conclusion, El Al Israel Airlines' accrual ratio suggests its earnings are well backed by cash but its boost from unusual items, and a tax benefit, probably mean that the statutory number make the company seem more profitable than it is at an underlying level. Based on these factors, we think that El Al Israel Airlines' statutory profits probably make it seem better than it is on an underlying level. If you want to do dive deeper into El Al Israel Airlines, you'd also look into what risks it is currently facing. For instance, we've identified 3 warning signs for El Al Israel Airlines (2 are significant) you should be familiar with.

Our examination of El Al Israel Airlines 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 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.