Weak Statutory Earnings May Not Tell The Whole Story For S.C. Hercules (BVB:HLEB)

Last week's earnings announcement from S.C. Hercules S.A. (BVB:HLEB) was disappointing to investors, with a sluggish profit figure. Our analysis has found some reasons to be concerned, beyond the weak headline numbers.

Check out our latest analysis for S.C. Hercules

Examining Cashflow Against S.C. Hercules' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

S.C. Hercules has an accrual ratio of 0.63 for the year to December 2023. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of RON3.6m, in contrast to the aforementioned profit of RON12.5m. We saw that FCF was RON33m a year ago though, so S.C. Hercules has at least been able to generate positive FCF in the past. The good news for shareholders is that S.C. Hercules' 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. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of S.C. Hercules.

Our Take On S.C. Hercules' Profit Performance

As we have made quite clear, we're a bit worried that S.C. Hercules didn't back up the last year's profit with free cashflow. For this reason, we think that S.C. Hercules' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. Keep in mind, when it comes to analysing a stock it's worth noting the risks involved. Case in point: We've spotted 3 warning signs for S.C. Hercules you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of S.C. Hercules' 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. 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.