Does SORIL Infra Resources's (NSE:SORILINFRA) Statutory Profit Adequately Reflect Its Underlying Profit?

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. Today we'll focus on whether this year's statutory profits are a good guide to understanding SORIL Infra Resources (NSE:SORILINFRA).

While SORIL Infra Resources was able to generate revenue of ₹1.84b in the last twelve months, we think its profit result of ₹169.2m was more important. In the last few years its profit has fallen, although its revenue was steady, as you can see in the chart below.

Check out our latest analysis for SORIL Infra Resources

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 SORIL Infra Resources' 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 SORIL Infra Resources.

Zooming In On SORIL Infra Resources' 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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

For the year to September 2020, SORIL Infra Resources had an accrual ratio of -0.30. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of ₹1.9b during the period, dwarfing its reported profit of ₹169.2m. Given that SORIL Infra Resources had negative free cash flow in the prior corresponding period, the trailing twelve month resul of ₹1.9b would seem to be a step in the right direction. 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.

How Do Unusual Items Influence Profit?

Surprisingly, given SORIL Infra Resources' accrual ratio implied strong cash conversion, its paper profit was actually boosted by ₹44m in unusual items. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. Which is hardly surprising, given the name. SORIL Infra Resources had a rather significant contribution from unusual items relative to its profit to September 2020. 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 SORIL Infra Resources' Profit Performance

SORIL Infra Resources' profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. After taking into account all these factors, we think that SORIL Infra Resources' statutory results are a decent reflection of its underlying earnings power. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Be aware that SORIL Infra Resources is showing 4 warning signs in our investment analysis and 2 of those are potentially serious...

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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 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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