We Think SK ChemicalsLtd's (KRX:285130) Robust Earnings Are Conservative

The subdued stock price reaction suggests that SK Chemicals Co.,Ltd.'s (KRX:285130) strong earnings didn't offer any surprises. We think that investors have missed some encouraging factors underlying the profit figures.

See our latest analysis for SK ChemicalsLtd

Zooming In On SK ChemicalsLtd's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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.

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. 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.

SK ChemicalsLtd has an accrual ratio of -0.11 for the year to December 2020. Therefore, its statutory earnings were quite a lot less than its free cashflow. In fact, it had free cash flow of ₩153b in the last year, which was a lot more than its statutory profit of ₩8.13b. Notably, SK ChemicalsLtd had negative free cash flow last year, so the ₩153b it produced this year was a welcome improvement. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

How Do Unusual Items Influence Profit?

SK ChemicalsLtd's profit was reduced by unusual items worth ₩55b 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. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. In the twelve months to December 2020, SK ChemicalsLtd had a big unusual items expense. All else being equal, this would likely have the effect of making the statutory profit look worse than its underlying earnings power.

Our Take On SK ChemicalsLtd's Profit Performance

In conclusion, both SK ChemicalsLtd's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think SK ChemicalsLtd's earnings potential is at least as good as it seems, and maybe even better! If you'd like to know more about SK ChemicalsLtd as a business, it's important to be aware of any risks it's facing. For example, we've discovered 3 warning signs that you should run your eye over to get a better picture of SK ChemicalsLtd.

Our examination of SK ChemicalsLtd 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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