Earnings Troubles May Signal Larger Issues for Chemfab Alkalis (NSE:CHEMFAB) Shareholders

Last week's earnings announcement from Chemfab Alkalis Limited (NSE:CHEMFAB) was disappointing to investors, with a sluggish profit figure. Our analysis has found some reasons to be concerned, beyond the weak headline numbers.

See our latest analysis for Chemfab Alkalis

Examining Cashflow Against Chemfab Alkalis' 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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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.

Over the twelve months to September 2024, Chemfab Alkalis recorded an accrual ratio of 0.23. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Over the last year it actually had negative free cash flow of ₹794m, in contrast to the aforementioned profit of ₹128.7m. We saw that FCF was ₹118m a year ago though, so Chemfab Alkalis has at least been able to generate positive FCF in the past. 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 Chemfab Alkalis.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Chemfab Alkalis' profit was boosted by unusual items worth ₹49m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. 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. If Chemfab Alkalis doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Chemfab Alkalis' Profit Performance

Chemfab Alkalis had a weak accrual ratio, but its profit did receive a boost from unusual items. For the reasons mentioned above, we think that a perfunctory glance at Chemfab Alkalis' statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into Chemfab Alkalis, you'd also look into what risks it is currently facing. When we did our research, we found 2 warning signs for Chemfab Alkalis (1 can't be ignored!) that we believe deserve your full attention.

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 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.