We're Not So Sure You Should Rely on Axas HoldingsLtd's (TYO:3536) Statutory Earnings

As a general rule, we think profitable companies are less risky than companies that lose money. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Axas HoldingsLtd's (TYO:3536) statutory profits are a good guide to its underlying earnings.

While Axas HoldingsLtd was able to generate revenue of JP¥12.5b in the last twelve months, we think its profit result of JP¥497.0m was more important.

See our latest analysis for Axas HoldingsLtd

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. So today we'll look at what Axas HoldingsLtd's cashflow tells us about its earnings, as well as examining how the receipt of a tax benefit has impacted its statutory earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Axas HoldingsLtd.

Zooming In On Axas HoldingsLtd'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. 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. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to August 2020, Axas HoldingsLtd had an accrual ratio of 0.22. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Even though it reported a profit of JP¥497.0m, a look at free cash flow indicates it actually burnt through JP¥1.9b in the last year. We also note that Axas HoldingsLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of JP¥1.9b. Importantly, we note an unusual tax situation, which we discuss below, has impacted the accruals ratio. This would certainly have contributed to the weak cash conversion.

An Unusual Tax Situation

Moving on from the accrual ratio, we note that Axas HoldingsLtd profited from a tax benefit which contributed JP¥180m to profit. This is of course a bit out of the ordinary, given it is more common for companies to be paying tax than receiving tax benefits! We're sure the company was pleased with its tax benefit. 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. Assuming the tax benefit is not repeated every year, we could see its profitability drop noticeably, all else being equal. 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 Axas HoldingsLtd's Profit Performance

This year, Axas HoldingsLtd couldn't match its profit with cashflow. On top of that, the unsustainable nature of tax benefits mean that there's a chance profit may be lower next year, certainly in the absence of strong growth. Considering all this we'd argue Axas HoldingsLtd's profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about Axas HoldingsLtd as a business, it's important to be aware of any risks it's facing. For instance, we've identified 4 warning signs for Axas HoldingsLtd (2 are concerning) you should be familiar with.

Our examination of Axas HoldingsLtd 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 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. 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.

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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.
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