We Think That There Are Some Issues For BW Offshore (OB:BWO) Beyond Its Promising Earnings

Following the solid earnings report from BW Offshore Limited (OB:BWO), the market responded by bidding up the stock price. However, we think that shareholders should be cautious as we found some worrying factors underlying the profit.

View our latest analysis for BW Offshore

Examining Cashflow Against BW Offshore's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. 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. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to March 2024, BW Offshore recorded an accrual ratio of 0.22. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Over the last year it actually had negative free cash flow of US$182m, in contrast to the aforementioned profit of US$118.9m. We also note that BW Offshore's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of US$182m. 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.

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.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by US$14m, in the last year, probably goes some way to explain why its accrual ratio was so weak. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. If BW Offshore doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On BW Offshore's Profit Performance

Summing up, BW Offshore received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue BW Offshore's profits probably give an overly generous impression of its sustainable level of profitability. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. To that end, you should learn about the 3 warning signs we've spotted with BW Offshore (including 2 which are concerning).

Our examination of BW Offshore 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. Some people consider a high return on equity to be a good sign of a quality business. 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.