We're Not So Sure You Should Rely on Alijarah Holding (Q.P.S.C.)'s (DSM:NLCS) Statutory Earnings

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. 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 Alijarah Holding (Q.P.S.C.) (DSM:NLCS).

While Alijarah Holding (Q.P.S.C.) was able to generate revenue of ر.ق134.8m in the last twelve months, we think its profit result of ر.ق18.8m was more important. The chart below shows that while revenue has fallen over the last three years, the company has moved from unprofitable to profitable.

View our latest analysis for Alijarah Holding (Q.P.S.C.)

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. So today we'll look at what Alijarah Holding (Q.P.S.C.)'s cashflow 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 Alijarah Holding (Q.P.S.C.).

Examining Cashflow Against Alijarah Holding (Q.P.S.C.)'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. 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'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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.

Alijarah Holding (Q.P.S.C.) has an accrual ratio of 0.39 for the year to September 2020. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Over the last year it actually had negative free cash flow of ر.ق83m, in contrast to the aforementioned profit of ر.ق18.8m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of ر.ق83m, this year, indicates high risk. 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.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Alijarah Holding (Q.P.S.C.)'s profit was boosted by unusual items worth ر.ق15m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. We can see that Alijarah Holding (Q.P.S.C.)'s positive unusual items were quite significant relative to its profit in the year to September 2020. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Alijarah Holding (Q.P.S.C.)'s Profit Performance

Summing up, Alijarah Holding (Q.P.S.C.) 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 Alijarah Holding (Q.P.S.C.)'s profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into Alijarah Holding (Q.P.S.C.), you'd also look into what risks it is currently facing. Our analysis shows 2 warning signs for Alijarah Holding (Q.P.S.C.) (1 is concerning!) and we strongly recommend you look at these before investing.

Our examination of Alijarah Holding (Q.P.S.C.) 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 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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