Weak Statutory Earnings May Not Tell The Whole Story For Paradeep Phosphates (NSE:PARADEEP)

The subdued market reaction suggests that Paradeep Phosphates Limited's (NSE:PARADEEP) recent earnings didn't contain any surprises. Our analysis suggests that along with soft profit numbers, investors should be aware of some other underlying weaknesses in the numbers.

Check out the opportunities and risks within the IN Chemicals industry.

Zooming In On Paradeep Phosphates' 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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. 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 2022, Paradeep Phosphates recorded an accrual ratio of 0.65. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of ₹2.77b, a look at free cash flow indicates it actually burnt through ₹33b in the last year. We saw that FCF was ₹3.3b a year ago though, so Paradeep Phosphates has at least been able to generate positive FCF in the past. The good news for shareholders is that Paradeep Phosphates' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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

Our Take On Paradeep Phosphates' Profit Performance

As we discussed above, we think Paradeep Phosphates' earnings were not supported by free cash flow, which might concern some investors. As a result, we think it may well be the case that Paradeep Phosphates' underlying earnings power is lower than its statutory profit. But at least holders can take some solace from the 37% per annum growth in EPS for the last three. 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 Paradeep Phosphates, you'd also look into what risks it is currently facing. For instance, we've identified 3 warning signs for Paradeep Phosphates (2 don't sit too well with us) you should be familiar with.

This note has only looked at a single factor that sheds light on the nature of Paradeep Phosphates' profit. 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 that insiders are buying.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.