Zodiac Energy (NSE:ZODIAC) Posted Healthy Earnings But There Are Some Other Factors To Be Aware Of

Last week's profit announcement from Zodiac Energy Limited (NSE:ZODIAC) was underwhelming for investors, despite headline numbers being robust. We think that the market might be paying attention to some underlying factors that they find to be concerning.

Check out our latest analysis for Zodiac Energy

Zooming In On Zodiac Energy's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Zodiac Energy has an accrual ratio of 0.67 for the year to September 2024. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of ₹587m despite its profit of ₹134.9m, mentioned above. We also note that Zodiac Energy's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹587m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Zodiac Energy.

Our Take On Zodiac Energy's Profit Performance

As we discussed above, we think Zodiac Energy's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that Zodiac Energy's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But on the bright side, its earnings per share have grown at an extremely impressive rate over the last three years. 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 Zodiac Energy at this point in time. When we did our research, we found 4 warning signs for Zodiac Energy (2 are potentially serious!) that we believe deserve your full attention.

This note has only looked at a single factor that sheds light on the nature of Zodiac Energy's profit. 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. 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.