We're Not So Sure You Should Rely on S.N.T.G.N. Transgaz's (BVB:TGN) Statutory Earnings

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. 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.N.T.G.N. Transgaz's (BVB:TGN) statutory profits are a good guide to its underlying earnings.

We like the fact that S.N.T.G.N. Transgaz made a profit of RON383.9m on its revenue of RON3.04b, 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.

Check out our latest analysis for S.N.T.G.N. Transgaz

Importantly, statutory profits are not always the best tool for understanding a company's true earnings power, so it's well worth examining profits in a little more detail. Today, we'll discuss S.N.T.G.N. Transgaz's free cashflow relative to its earnings, and consider what that tells us about the company. That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Zooming In On S.N.T.G.N. Transgaz'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. 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 having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to June 2020, S.N.T.G.N. Transgaz recorded an accrual ratio of 0.31. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. Even though it reported a profit of RON383.9m, a look at free cash flow indicates it actually burnt through RON753m in the last year. We also note that S.N.T.G.N. Transgaz's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of RON753m.

Our Take On S.N.T.G.N. Transgaz's Profit Performance

S.N.T.G.N. Transgaz's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that S.N.T.G.N. Transgaz's statutory profits are better than its underlying earnings power. In further bad news, its earnings per share decreased in the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. To help with this, we've discovered 3 warning signs (2 are concerning!) that you ought to be aware of before buying any shares in S.N.T.G.N. Transgaz.

This note has only looked at a single factor that sheds light on the nature of S.N.T.G.N. Transgaz's profit. But there are plenty of other ways to inform your opinion of a company. 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. 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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