There Are Some Holes In Huhtamaki India's (NSE:HUHTAMAKI) Solid Earnings Release

Shareholders didn't seem to be thrilled with Huhtamaki India Limited's (NSE:HUHTAMAKI) recent earnings report, despite healthy profit numbers. We think that they might be concerned about some underlying details that our analysis found.

View our latest analysis for Huhtamaki India

Zooming In On Huhtamaki India'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). 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'.

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

For the year to December 2023, Huhtamaki India had an accrual ratio of 0.23. Unfortunately, that means its free cash flow fell significantly short of its reported profits. To wit, it produced free cash flow of ₹1.8b during the period, falling well short of its reported profit of ₹4.10b. At this point we should mention that Huhtamaki India did manage to increase its free cash flow in the last twelve months Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by ₹3.7b, in the last year, probably goes some way to explain why its accrual ratio was so weak. 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 crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. Huhtamaki India had a rather significant contribution from unusual items relative to its profit to December 2023. 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 Huhtamaki India's Profit Performance

Huhtamaki India had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Huhtamaki India's profits probably give an overly generous impression of its sustainable level of profitability. So while earnings quality is important, it's equally important to consider the risks facing Huhtamaki India at this point in time. Our analysis shows 3 warning signs for Huhtamaki India (2 can't be ignored!) and we strongly recommend you look at them before investing.

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 is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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. 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.