Why B-R 31 Ice CreamLtd's (TYO:2268) Earnings Are Better Than They Seem

B-R 31 Ice Cream Co.,Ltd.'s (TYO:2268) solid earnings announcement recently didn't do much to the stock price. We did some analysis to find out why and believe that investors might be missing some encouraging factors contained in the earnings.

See our latest analysis for B-R 31 Ice CreamLtd

A Closer Look At B-R 31 Ice CreamLtd'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to December 2020, B-R 31 Ice CreamLtd recorded an accrual ratio of -0.21. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of JP¥2.4b during the period, dwarfing its reported profit of JP¥442.0m. Given that B-R 31 Ice CreamLtd had negative free cash flow in the prior corresponding period, the trailing twelve month resul of JP¥2.4b would seem to be a step in the right direction. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of B-R 31 Ice CreamLtd.

How Do Unusual Items Influence Profit?

B-R 31 Ice CreamLtd's profit was reduced by unusual items worth JP¥65m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect B-R 31 Ice CreamLtd to produce a higher profit next year, all else being equal.

Our Take On B-R 31 Ice CreamLtd's Profit Performance

In conclusion, both B-R 31 Ice CreamLtd's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think B-R 31 Ice CreamLtd's underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! Just as investors must consider earnings, it is also important to take into account the strength of a company's balance sheet. You can see our latest analysis on B-R 31 Ice CreamLtd's balance sheet health here.

Our examination of B-R 31 Ice CreamLtd has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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. 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.

If you’re looking to trade B-R 31 Ice CreamLtd, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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