Investors Shouldn't Be Too Comfortable With KIOCL's (NSE:KIOCL) Robust Earnings

KIOCL Limited's (NSE:KIOCL) stock was strong after they reported robust earnings. We did some analysis and think that investors are missing some details hidden beneath the profit numbers.

Check out our latest analysis for KIOCL

Examining Cashflow Against KIOCL's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. 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 March 2021, KIOCL recorded an accrual ratio of 0.49. Ergo, its free cash flow is significantly weaker than its profit. As a general rule, that bodes poorly for future profitability. In fact, it had free cash flow of ₹695m in the last year, which was a lot less than its statutory profit of ₹3.01b. Notably, KIOCL had negative free cash flow last year, so the ₹695m it produced this year was a welcome improvement.

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

Our Take On KIOCL's Profit Performance

As we have made quite clear, we're a bit worried that KIOCL didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that KIOCL's underlying earnings power is lower than its statutory profit. But the good news is that its EPS growth over the last three years has been very impressive. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you want to do dive deeper into KIOCL, you'd also look into what risks it is currently facing. For example, we've found that KIOCL has 3 warning signs (1 is a bit unpleasant!) that deserve your attention before going any further with your analysis.

Today we've zoomed in on a single data point to better understand the nature of KIOCL's profit. But there are plenty of other ways to inform your opinion of a company. 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. 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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