We Think SeAH Steel Holdings' (KRX:003030) Healthy Earnings Might Be Conservative

SeAH Steel Holdings Corporation's (KRX:003030) recent earnings report didn't offer any surprises, with the shares unchanged over the last week. We did some analysis to find out why and believe that investors might be missing some encouraging factors contained in the earnings.

Check out our latest analysis for SeAH Steel Holdings

Examining Cashflow Against SeAH Steel Holdings' 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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".

SeAH Steel Holdings has an accrual ratio of -0.11 for the year to December 2020. That implies it has good cash conversion, and implies that its free cash flow solidly exceeded its profit last year. Indeed, in the last twelve months it reported free cash flow of ₩207b, well over the ₩17.1b it reported in profit. SeAH Steel Holdings shareholders are no doubt pleased that free cash flow improved over the last twelve months. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

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

How Do Unusual Items Influence Profit?

SeAH Steel Holdings' profit was reduced by unusual items worth ₩8.9b 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. Assuming those unusual expenses don't come up again, we'd therefore expect SeAH Steel Holdings to produce a higher profit next year, all else being equal.

Our Take On SeAH Steel Holdings' Profit Performance

In conclusion, both SeAH Steel Holdings' accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think SeAH Steel Holdings' earnings potential is at least as good as it seems, and maybe even better! Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. For instance, we've identified 3 warning signs for SeAH Steel Holdings (1 can't be ignored) you should be familiar with.

Our examination of SeAH Steel Holdings 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 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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