SIF Hoteluri's (BVB:CAOR) Performance Raises Some Questions

After announcing healthy earnings, SIF Hoteluri S.A.'s (BVB:CAOR) stock rose over the last week. Despite the strong profit numbers, we believe that there are some deeper issues which investors should look into.

See our latest analysis for SIF Hoteluri

A Closer Look At SIF Hoteluri'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. 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. The ratio shows us how much a company's profit exceeds its FCF.

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. 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.

SIF Hoteluri has an accrual ratio of 0.54 for the year to September 2023. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. In the last twelve months it actually had negative free cash flow, with an outflow of RON12m despite its profit of RON7.67m, mentioned above. It's worth noting that SIF Hoteluri generated positive FCF of RON25m a year ago, so at least they've done it in the past. 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 good news for shareholders is that SIF Hoteluri's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of SIF Hoteluri.

The Impact Of Unusual Items On Profit

As it happens, there are a few different things to consider when we look at SIF Hoteluri's profit and the last one we'll mention is RON1.1m gain booked as unusual items. 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. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On SIF Hoteluri's Profit Performance

SIF Hoteluri had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue SIF Hoteluri'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 SIF Hoteluri at this point in time. Every company has risks, and we've spotted 3 warning signs for SIF Hoteluri (of which 1 can't be ignored!) you should know about.

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. 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. 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.