Aeon Kyushu's (TSE:2653) Earnings Offer More Than Meets The Eye

The market seemed underwhelmed by last week's earnings announcement from Aeon Kyushu Co., Ltd. (TSE:2653) despite the healthy numbers. We did some digging, and we think that investors are missing some encouraging factors in the underlying numbers.

Check out our latest analysis for Aeon Kyushu

Examining Cashflow Against Aeon Kyushu's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Aeon Kyushu has an accrual ratio of -0.21 for the year to August 2024. 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¥12b, well over the JP¥5.15b it reported in profit. As it happens we don't have the data on what Aeon Kyushu produced by way of free cashflow, the year before, which is a pity. However, we can see that a recent tax benefit, along with unusual items, have impacted its statutory profit, and therefore its accrual ratio.

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

How Do Unusual Items Influence Profit?

Aeon Kyushu's profit was reduced by unusual items worth JP¥4.1b in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. In the twelve months to August 2024, Aeon Kyushu had a big unusual items expense. As a result, we can surmise that the unusual items made its statutory profit significantly weaker than it would otherwise be.

An Unusual Tax Situation

Moving on from the accrual ratio, we note that Aeon Kyushu profited from a tax benefit which contributed JP¥1.1b to profit. This is meaningful because companies usually pay tax rather than receive tax benefits. The receipt of a tax benefit is obviously a good thing, on its own. However, our data indicates that tax benefits can temporarily boost statutory profit in the year it is booked, but subsequently profit may fall back. Assuming the tax benefit is not repeated every year, we could see its profitability drop noticeably, all else being equal.

Our Take On Aeon Kyushu's Profit Performance

Summing up, Aeon Kyushu's accrual ratio and its unusual items suggest that its statutory earnings were temporarily depressed, while its tax benefit is having the opposite effect. Looking at all these factors, we'd say that Aeon Kyushu's underlying earnings power is at least as good as the statutory numbers would make it seem. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Every company has risks, and we've spotted 2 warning signs for Aeon Kyushu you should know about.

Our examination of Aeon Kyushu has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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 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.