Here's Why We Don't Think Saudi Cable's (TADAWUL:2110) Statutory Earnings Reflect Its Underlying Earnings Potential

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. This article will consider whether Saudi Cable's (TADAWUL:2110) statutory profits are a good guide to its underlying earnings.

It's good to see that over the last twelve months Saudi Cable made a profit of ر.س4.00m on revenue of ر.س403.9m. Even though revenue is down over the last three years, you can see in the chart below that the company has moved from loss-making to profitable.

Check out our latest analysis for Saudi Cable

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. So this article aims to better understand Saudi Cable's underlying earnings power by taking a look at how dilution, and unusual items are impacting it, and considering how well those paper profits are being converted into cash flow. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Saudi Cable.

Examining Cashflow Against Saudi Cable'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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.

Over the twelve months to September 2020, Saudi Cable recorded an accrual ratio of 0.41. 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 ر.س4.00m, a look at free cash flow indicates it actually burnt through ر.س249m in the last year. We also note that Saudi Cable's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of ر.س249m. Having said that, there is more to consider. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. In fact, Saudi Cable increased the number of shares on issue by 226% over the last twelve months by issuing new shares. As a result, its net income is now split between a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. You can see a chart of Saudi Cable's EPS by clicking here.

How Is Dilution Impacting Saudi Cable's Earnings Per Share? (EPS)

Saudi Cable was losing money three years ago. And even focusing only on the last twelve months, we don't have a meaningful growth rate because it made a loss a year ago, too. But mathematics aside, it is always good to see when a formerly unprofitable business come good (though we accept profit would have been higher if dilution had not been required). Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.

If Saudi Cable's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by ر.س25m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. If Saudi Cable 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 Saudi Cable's Profit Performance

In conclusion, Saudi Cable's weak accrual ratio suggested its statutory earnings have been inflated by the unusual items. Meanwhile, the new shares issued mean that shareholders now own less of the company, unless they tipped in more cash themselves. On reflection, the above-mentioned factors give us the strong impression that Saudi Cable'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. So while earnings quality is important, it's equally important to consider the risks facing Saudi Cable at this point in time. To help with this, we've discovered 4 warning signs (3 are a bit concerning!) that you ought to be aware of before buying any shares in Saudi Cable.

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. 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 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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