Hindustan Foods (NSE:HNDFDS) Is Growing Earnings But Are They A Good Guide?

Broadly speaking, profitable businesses are less risky than unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Hindustan Foods' (NSE:HNDFDS) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Hindustan Foods made a profit of ₹219.1m on revenue of ₹7.72b. We know some investors love those high revenue growth stocks, but we do like to look at profit, even if it is, perhaps, a bit old fashioned. One positive is that it has grown both its profit and its revenue, over the last few years.

View our latest analysis for Hindustan Foods

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we'll examine what Hindustan Foods' cashflow and its expanding share count tell us about the nature of its profits. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hindustan Foods.

Zooming In On Hindustan Foods' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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.

Hindustan Foods has an accrual ratio of 0.66 for the year to March 2020. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of ₹1.1b, in contrast to the aforementioned profit of ₹219.1m. We also note that Hindustan Foods' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹1.1b. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. As it happens, Hindustan Foods issued 57% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. You can see a chart of Hindustan Foods' EPS by clicking here.

A Look At The Impact Of Hindustan Foods' Dilution on Its Earnings Per Share (EPS).

As you can see above, Hindustan Foods has been growing its net income over the last few years, with an annualized gain of 3,079% over three years. But EPS was only up 1,170% per year, in the exact same period. And the 115% profit boost in the last year certainly seems impressive at first glance. But in comparison, EPS only increased by 51% over the same period. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

In the long term, earnings per share growth should beget share price growth. So Hindustan Foods shareholders will want to see that EPS figure continue to increase. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Hindustan Foods' Profit Performance

As it turns out, Hindustan Foods couldn't match its profit with cashflow and its dilution means that earnings per share growth is lagging net income growth. On reflection, the above-mentioned factors give us the strong impression that Hindustan Foods'underlying earnings power is not as good as it might seem, based on the statutory profit numbers. So while earnings quality is important, it's equally important to consider the risks facing Hindustan Foods at this point in time. For example, we've found that Hindustan Foods has 5 warning signs (3 are a bit concerning!) that deserve your attention before going any further with your analysis.

Our examination of Hindustan Foods 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. 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. 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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