We're Not Counting On Mishra Dhatu Nigam (NSE:MIDHANI) To Sustain Its Statutory Profitability

Broadly speaking, profitable businesses are less risky than unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Mishra Dhatu Nigam's (NSE:MIDHANI) statutory profits are a good guide to its underlying earnings.

While Mishra Dhatu Nigam was able to generate revenue of ₹6.88b in the last twelve months, we think its profit result of ₹1.32b was more important. Even though its revenue is down over the last three years, its profit has actually increased, as you can see, below.

See our latest analysis for Mishra Dhatu Nigam

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. As a result, today we're going to take a closer look at Mishra Dhatu Nigam's cashflow, and unusual items, with a view to understanding what these might tell us about its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Mishra Dhatu Nigam.

Zooming In On Mishra Dhatu Nigam'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. 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 2020, Mishra Dhatu Nigam recorded an accrual ratio of 0.40. 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 ₹1.32b, a look at free cash flow indicates it actually burnt through ₹2.3b in the last year. It's worth noting that Mishra Dhatu Nigam generated positive FCF of ₹930m a year ago, so at least they've done it in the past. 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.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Mishra Dhatu Nigam's profit was boosted by unusual items worth ₹124m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And, after all, that's exactly what the accounting terminology implies. If Mishra Dhatu Nigam 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 Mishra Dhatu Nigam's Profit Performance

Summing up, Mishra Dhatu Nigam received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For the reasons mentioned above, we think that a perfunctory glance at Mishra Dhatu Nigam's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Mishra Dhatu Nigam as a business, it's important to be aware of any risks it's facing. Our analysis shows 2 warning signs for Mishra Dhatu Nigam (1 can't be ignored!) and we strongly recommend you look at them before investing.

Our examination of Mishra Dhatu Nigam has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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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