TSUKURUBA's (TSE:2978) Attractive Earnings Are Not All Good News For Shareholders

Despite posting strong earnings, TSUKURUBA Inc.'s (TSE:2978) stock didn't move much over the last week. We think that investors might be worried about the foundations the earnings are built on.

See our latest analysis for TSUKURUBA

A Closer Look At TSUKURUBA's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

TSUKURUBA has an accrual ratio of 0.79 for the year to July 2024. 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. Over the last year it actually had negative free cash flow of JP¥939m, in contrast to the aforementioned profit of JP¥215.7m. We also note that TSUKURUBA's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of JP¥939m. However, we can see that a recent tax benefit, along with unusual items, have impacted its statutory profit, and therefore its accrual ratio. The good news for shareholders is that TSUKURUBA's 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. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by JP¥86m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. We can see that TSUKURUBA's positive unusual items were quite significant relative to its profit in the year to July 2024. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

An Unusual Tax Situation

Moving on from the accrual ratio, we note that TSUKURUBA profited from a tax benefit which contributed JP¥16m to profit. It's always a bit noteworthy when a company is paid by the tax man, rather than paying the tax man. The receipt of a tax benefit is obviously a good thing, on its own. And since it previously lost money, it may well simply indicate the realisation of past tax losses. However, the devil in the detail is that these kind of benefits only impact in the year they are booked, and are often one-off in nature. In the likely event the tax benefit is not repeated, we'd expect to see its statutory profit levels drop, at least in the absence of strong growth. So while we think it's great to receive a tax benefit, it does tend to imply an increased risk that the statutory profit overstates the sustainable earnings power of the business.

Our Take On TSUKURUBA's Profit Performance

Summing up, TSUKURUBA's tax benefit and unusual items boosted its statutory profit leading to poor cash conversion, as reflected by its accrual ratio. For all the reasons mentioned above, we think that, at a glance, TSUKURUBA's statutory profits could be considered to be low quality, because they are likely to give investors an overly positive impression of the company. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For example, TSUKURUBA has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

Our examination of TSUKURUBA 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. 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 with high insider ownership.

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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.