There May Be Reason For Hope In Frontier International's (TSE:7050) Disappointing Earnings

The market for Frontier International Inc.'s (TSE:7050) shares didn't move much after it posted weak earnings recently. We did some digging, and we believe the earnings are stronger than they seem.

See our latest analysis for Frontier International

A Closer Look At Frontier International's 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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. The ratio shows us how much a company's profit exceeds its FCF.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to October 2024, Frontier International recorded an accrual ratio of -0.33. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of JP¥1.2b, well over the JP¥274.0m it reported in profit. Frontier International did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie. 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.

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

How Do Unusual Items Influence Profit?

Frontier International's profit was reduced by unusual items worth JP¥288m 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. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. If Frontier International doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Frontier International's Profit Performance

In conclusion, both Frontier International's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think Frontier International's underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Our analysis shows 5 warning signs for Frontier International (1 is a bit concerning!) and we strongly recommend you look at them before investing.

Our examination of Frontier International 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. Some people consider a high return on equity to be a good sign of a quality business. 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.