Shareholders Will Be Pleased With The Quality of Hindustan Copper's (NSE:HINDCOPPER) Earnings

Even though Hindustan Copper Limited's (NSE:HINDCOPPER) recent earnings release was robust, the market didn't seem to notice. Investors are probably missing some underlying factors which are encouraging for the future of the company.

View our latest analysis for Hindustan Copper

A Closer Look At Hindustan Copper's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Hindustan Copper has an accrual ratio of -0.15 for the year to March 2021. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of ₹4.7b during the period, dwarfing its reported profit of ₹1.10b. Given that Hindustan Copper had negative free cash flow in the prior corresponding period, the trailing twelve month resul of ₹4.7b would seem to be a step in the right direction. Importantly, we note an unusual tax situation, which we discuss below, has impacted the accruals ratio.

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

An Unusual Tax Situation

In addition to the notable accrual ratio, we can see that Hindustan Copper received a tax benefit of ₹230m. This is meaningful because companies usually pay tax rather than receive tax benefits. We're sure the company was pleased with its tax benefit. And given that it lost money last year, it seems possible that the benefit is evidence that it now expects to find value in its past tax losses. However, the devil in the detail is that these kind of benefits only impact in the year they are booked, and are often one-off in nature. In the likely event the tax benefit is not repeated, we'd expect to see its statutory profit levels drop, at least in the absence of strong growth. While we think it's good that the company has booked a tax benefit, it does mean that there's every chance the statutory profit will come in a lot higher than it would be if the income was adjusted for one-off factors.

Our Take On Hindustan Copper's Profit Performance

In conclusion, Hindustan Copper has strong cashflow relative to earnings, which indicates good quality earnings, but the tax benefit means its profit wasn't as sustainable as we'd like to see. Considering all the aforementioned, we'd venture that Hindustan Copper's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. If you want to do dive deeper into Hindustan Copper, you'd also look into what risks it is currently facing. When we did our research, we found 3 warning signs for Hindustan Copper (1 is a bit unpleasant!) 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, 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. 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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