Ashapura Minechem's (NSE:ASHAPURMIN) Weak Earnings Might Be Worse Than They Appear

Shareholders didn't appear too concerned by Ashapura Minechem Limited's (NSE:ASHAPURMIN) weak earnings. We did some digging, and we believe that investors are missing some worrying factors underlying the profit figures.

See our latest analysis for Ashapura Minechem

A Closer Look At Ashapura Minechem's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to March 2021, Ashapura Minechem had an accrual ratio of 0.63. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of ₹874.8m, a look at free cash flow indicates it actually burnt through ₹4.6b in the last year. We also note that Ashapura Minechem's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ₹4.6b. 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.

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

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by ₹193m, in the last year, probably goes some way to explain why its accrual ratio was so weak. 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. Ashapura Minechem had a rather significant contribution from unusual items relative to its profit to March 2021. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Ashapura Minechem's Profit Performance

Summing up, Ashapura Minechem received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Ashapura Minechem's profits probably give an overly generous impression of its sustainable level of profitability. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, we've found that Ashapura Minechem has 4 warning signs (2 are a bit unpleasant!) that deserve your attention before going any further with your analysis.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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 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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