Here's Why We Don't Think Amtel Holdings Berhad's (KLSE:AMTEL) Statutory Earnings Reflect Its Underlying Earnings Potential

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. This article will consider whether Amtel Holdings Berhad's (KLSE:AMTEL) statutory profits are a good guide to its underlying earnings.

While Amtel Holdings Berhad was able to generate revenue of RM56.0m in the last twelve months, we think its profit result of RM4.31m was more important. The good news is that the company managed to grow its revenue over the last three years, and also move from loss-making to profitable.

View our latest analysis for Amtel Holdings Berhad

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. So today we'll examine what Amtel Holdings Berhad's cashflow and its expanding share count tell us about the nature of its profits. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Amtel Holdings Berhad.

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

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. 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. 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 November 2020, Amtel Holdings Berhad had an accrual ratio of 0.84. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of RM19m, in contrast to the aforementioned profit of RM4.31m. It's worth noting that Amtel Holdings Berhad generated positive FCF of RM7.6m a year ago, so at least they've done it in the past. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings. The good news for shareholders is that Amtel Holdings Berhad's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. As it happens, Amtel Holdings Berhad issued 20% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. Check out Amtel Holdings Berhad's historical EPS growth by clicking on this link.

How Is Dilution Impacting Amtel Holdings Berhad's Earnings Per Share? (EPS)

Three years ago, Amtel Holdings Berhad lost money. And even focusing only on the last twelve months, we see profit is down 11%. Sadly, earnings per share fell further, down a full 13% in that time. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.

If Amtel Holdings Berhad's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On Amtel Holdings Berhad's Profit Performance

As it turns out, Amtel Holdings Berhad couldn't match its profit with cashflow and its dilution means that shareholders own less of the company than the did before (unless they bought more shares). Considering all this we'd argue Amtel Holdings Berhad's profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about Amtel Holdings Berhad as a business, it's important to be aware of any risks it's facing. To that end, you should learn about the 4 warning signs we've spotted with Amtel Holdings Berhad (including 1 which is potentially serious).

Our examination of Amtel Holdings Berhad 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. 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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