Does Hankook Shell OilLtd's (KRX:002960) Statutory Profit Adequately Reflect Its Underlying Profit?

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. In this article, we'll look at how useful this year's statutory profit is, when analysing Hankook Shell OilLtd (KRX:002960).

We like the fact that Hankook Shell OilLtd made a profit of ₩23.8b on its revenue of ₩203.0b, in the last year. The chart below shows that both revenue and profit have declined over the last three years.

See our latest analysis for Hankook Shell OilLtd

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. Today, we'll discuss Hankook Shell OilLtd's free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hankook Shell OilLtd.

Examining Cashflow Against Hankook Shell OilLtd'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. 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. 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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Hankook Shell OilLtd has an accrual ratio of -0.18 for the year to September 2020. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of ₩31b in the last year, which was a lot more than its statutory profit of ₩23.8b. Hankook Shell OilLtd shareholders are no doubt pleased that free cash flow improved over the last twelve months.

Our Take On Hankook Shell OilLtd's Profit Performance

As we discussed above, Hankook Shell OilLtd's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Hankook Shell OilLtd's statutory profit actually understates its earnings potential! And the EPS is up 5.6% over the last twelve months. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. So while earnings quality is important, it's equally important to consider the risks facing Hankook Shell OilLtd at this point in time. At Simply Wall St, we found 1 warning sign for Hankook Shell OilLtd and we think they deserve your attention.

Today we've zoomed in on a single data point to better understand the nature of Hankook Shell OilLtd's profit. 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. 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 that insiders are buying to be useful.

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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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