West Coast Paper Mills' (NSE:WSTCSTPAPR) Solid Earnings May Rest On Weak Foundations

The market shrugged off West Coast Paper Mills Limited's (NSE:WSTCSTPAPR) solid earnings report. Our analysis showed that there are some concerning factors in the earnings that investors may be cautious of.

See our latest analysis for West Coast Paper Mills

A Closer Look At West Coast Paper Mills' Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. 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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

West Coast Paper Mills has an accrual ratio of 0.24 for the year to March 2024. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. In fact, it had free cash flow of ₹4.8b in the last year, which was a lot less than its statutory profit of ₹13.8b. West Coast Paper Mills shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. One positive for West Coast Paper Mills shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. 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 West Coast Paper Mills.

Our Take On West Coast Paper Mills' Profit Performance

West Coast Paper Mills' accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that West Coast Paper Mills' statutory profits are better than its underlying earnings power. But at least holders can take some solace from the 47% EPS growth in the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you'd like to know more about West Coast Paper Mills as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 2 warning signs for West Coast Paper Mills you should be mindful of and 1 of these is a bit concerning.

This note has only looked at a single factor that sheds light on the nature of West Coast Paper Mills' 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 with significant insider holdings 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.