Zaklady Azotowe Pulawy's (WSE:ZAP) Conservative Accounting Might Explain Soft Earnings

The market for Zaklady Azotowe Pulawy S.A.'s (WSE:ZAP) shares didn't move much after it posted weak earnings recently. Our analysis suggests that while the profits are soft, the foundations of the business are strong.

Check out our latest analysis for Zaklady Azotowe Pulawy

A Closer Look At Zaklady Azotowe Pulawy'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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. 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. 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 December 2020, Zaklady Azotowe Pulawy had an accrual ratio of -0.14. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of zł610m during the period, dwarfing its reported profit of zł215.9m. Zaklady Azotowe Pulawy's free cash flow improved over the last year, which is generally good to see.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Zaklady Azotowe Pulawy.

Our Take On Zaklady Azotowe Pulawy's Profit Performance

As we discussed above, Zaklady Azotowe Pulawy has perfectly satisfactory free cash flow relative to profit. Because of this, we think Zaklady Azotowe Pulawy's earnings potential is at least as good as it seems, and maybe even better! On the other hand, its EPS actually shrunk in the last twelve months. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Our analysis shows 2 warning signs for Zaklady Azotowe Pulawy (1 is a bit unpleasant!) and we strongly recommend you look at these before investing.

This note has only looked at a single factor that sheds light on the nature of Zaklady Azotowe Pulawy's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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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