We Think China Aviation Oil (Singapore)'s (SGX:G92) Statutory Profit Might Understate Its Earnings Potential

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 China Aviation Oil (Singapore)'s (SGX:G92) statutory profits are a good guide to its underlying earnings.

While China Aviation Oil (Singapore) was able to generate revenue of US$16.0b in the last twelve months, we think its profit result of US$68.6m was more important. The chart below shows how it has grown revenue over the last three years, but that profit has declined.

View our latest analysis for China Aviation Oil (Singapore)

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. As a result, we think it's well worth considering what China Aviation Oil (Singapore)'s cashflow (when compared to its earnings) can tell us about the nature of its statutory profit. 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.

Examining Cashflow Against China Aviation Oil (Singapore)'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

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. 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".

For the year to June 2020, China Aviation Oil (Singapore) had an accrual ratio of -0.20. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of US$170m during the period, dwarfing its reported profit of US$68.6m. Given that China Aviation Oil (Singapore) had negative free cash flow in the prior corresponding period, the trailing twelve month resul of US$170m would seem to be a step in the right direction.

Our Take On China Aviation Oil (Singapore)'s Profit Performance

As we discussed above, China Aviation Oil (Singapore)'s accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that China Aviation Oil (Singapore)'s statutory profit actually understates its earnings potential! On the other hand, its EPS actually shrunk in the last twelve months. 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. If you'd like to know more about China Aviation Oil (Singapore) as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 1 warning sign for China Aviation Oil (Singapore) you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of China Aviation Oil (Singapore)'s profit. 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. 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.

If you’re looking to trade China Aviation Oil (Singapore), open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.