We Think You Can Look Beyond Munjal Auto Industries' (NSE:MUNJALAU) Lackluster Earnings

Soft earnings didn't appear to concern Munjal Auto Industries Limited's (NSE:MUNJALAU) shareholders over the last week. We did some digging, and we believe the earnings are stronger than they seem.

View our latest analysis for Munjal Auto Industries

A Closer Look At Munjal Auto 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). 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. The ratio shows us how much a company's profit exceeds its FCF.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Munjal Auto Industries has an accrual ratio of -0.14 for the year to March 2024. That indicates that its free cash flow was a fair bit more than its statutory profit. Indeed, in the last twelve months it reported free cash flow of ₹861m, well over the ₹384.9m it reported in profit. Munjal Auto Industries shareholders are no doubt pleased that free cash flow improved over the last twelve months. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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

The Impact Of Unusual Items On Profit

Munjal Auto Industries' profit was reduced by unusual items worth ₹119m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. If Munjal Auto Industries doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Munjal Auto Industries' Profit Performance

In conclusion, both Munjal Auto Industries' accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think Munjal Auto Industries' earnings potential is at least as good as it seems, and maybe even better! If you want to do dive deeper into Munjal Auto Industries, you'd also look into what risks it is currently facing. While conducting our analysis, we found that Munjal Auto Industries has 2 warning signs and it would be unwise to ignore them.

Our examination of Munjal Auto Industries 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. Some people consider a high return on equity to be a good sign of a quality business. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.