Beyond Lackluster Earnings: Potential Concerns For S.C. Prebet Aiud's (BVB:PREB) Shareholders

S.C. Prebet Aiud S.A.'s (BVB:PREB) lackluster earnings announcement last week disappointed investors. We think there is more to the story than simply soft profit numbers. Our analysis shows that there are some other factors of concern.

Check out our latest analysis for S.C. Prebet Aiud

Examining Cashflow Against S.C. Prebet Aiud'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. 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'.

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.

S.C. Prebet Aiud has an accrual ratio of 0.85 for the year to June 2024. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of RON5.00m, a look at free cash flow indicates it actually burnt through RON51m in the last year. It's worth noting that S.C. Prebet Aiud generated positive FCF of RON10m a year ago, so at least they've done it in the past. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part. The good news for shareholders is that S.C. Prebet Aiud'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 S.C. Prebet Aiud.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that S.C. Prebet Aiud's profit was boosted by unusual items worth RON453k in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. 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. If S.C. Prebet Aiud doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On S.C. Prebet Aiud's Profit Performance

Summing up, S.C. Prebet Aiud 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. Prebet Aiud's profits probably give an overly generous impression of its sustainable level of profitability. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Be aware that S.C. Prebet Aiud is showing 4 warning signs in our investment analysis and 2 of those are a bit unpleasant...

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 with significant insider holdings 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.