We're Not So Sure You Should Rely on Scana's (OB:SCANA) Statutory Earnings

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. Today we'll focus on whether this year's statutory profits are a good guide to understanding Scana (OB:SCANA).

We like the fact that Scana made a profit of kr37.7m on its revenue of kr306.0m, in the last year. Even though revenue is down over the last three years, you can see in the chart below that the company has moved from loss-making to profitable.

See our latest analysis for Scana

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we'll look at what Scana's cashflow, tax benefits and unusual items tell us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Scana.

Zooming In On Scana'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'.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to September 2020, Scana had 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. Indeed, in the last twelve months it reported free cash flow of kr16m, which is significantly less than its profit of kr37.7m. Scana's free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits. Having said that it seems that a recent tax benefit and some unusual items have impacted its profit (and this its accrual ratio).

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by kr2.3m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. 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. Scana had a rather significant contribution from unusual items relative to its profit to September 2020. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

An Unusual Tax Situation

Moving on from the accrual ratio, we note that Scana profited from a tax benefit which contributed kr36m to profit. This is meaningful because companies usually pay tax rather than receive tax benefits. The receipt of a tax benefit is obviously a good thing, on its own. However, the devil in the detail is that these kind of benefits only impact in the year they are booked, and are often one-off in nature. Assuming the tax benefit is not repeated every year, we could see its profitability drop noticeably, all else being equal.

Our Take On Scana's Profit Performance

In conclusion, Scana's weak accrual ratio suggests its statutory earnings have been inflated by the non-cash tax benefit and the boost it received from unusual items. For all the reasons mentioned above, we think that, at a glance, Scana's statutory profits could be considered to be low quality, because they are likely to give investors an overly positive impression of the company. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, we've found that Scana has 4 warning signs (2 are significant!) that deserve your attention before going any further with your analysis.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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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