We Wouldn't Rely On S.C. Ropharma's (BVB:RPH) Statutory Earnings As A Guide

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. 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 S.C. Ropharma's (BVB:RPH) statutory profits are a good guide to its underlying earnings.

We like the fact that S.C. Ropharma made a profit of RON5.44m on its revenue of RON768.9m, in the last year. As you can see in the chart below, its profit has declined over the last three years, even though its revenue has increased.

See our latest analysis for S.C. Ropharma

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. As a result, today we're going to take a closer look at S.C. Ropharma's cashflow, and unusual items, with a view to understanding what these might tell us about its statutory profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of S.C. Ropharma.

Zooming In On S.C. Ropharma's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. 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.

S.C. Ropharma has an accrual ratio of 0.23 for the year to June 2020. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In the last twelve months it actually had negative free cash flow, with an outflow of RON53m despite its profit of RON5.44m, mentioned above. We also note that S.C. Ropharma's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of RON53m. 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.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that S.C. Ropharma's profit was boosted by unusual items worth RON2.7m 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, after all, that's exactly what the accounting terminology implies. S.C. Ropharma had a rather significant contribution from unusual items relative to its profit to June 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 S.C. Ropharma's Profit Performance

Summing up, S.C. Ropharma 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 S.C. Ropharma's profits probably give an overly generous impression of its sustainable level of profitability. So while earnings quality is important, it's equally important to consider the risks facing S.C. Ropharma at this point in time. Case in point: We've spotted 6 warning signs for S.C. Ropharma you should be mindful of and 3 of these are potentially serious.

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 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. 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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