The Strong Earnings Posted By Isetan (Singapore) (SGX:I15) Are A Good Indication Of The Strength Of The Business

The subdued stock price reaction suggests that Isetan (Singapore) Limited's (SGX:I15) strong earnings didn't offer any surprises. Our analysis suggests that investors might be missing some promising details.

See our latest analysis for Isetan (Singapore)

A Closer Look At Isetan (Singapore)'s Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 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 December 2021, Isetan (Singapore) recorded an accrual ratio of -0.54. That indicates that its free cash flow quite significantly exceeded its statutory profit. To wit, it produced free cash flow of S$23m during the period, dwarfing its reported profit of S$2.16m. Isetan (Singapore) shareholders are no doubt pleased that free cash flow improved over the last twelve months. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Isetan (Singapore).

How Do Unusual Items Influence Profit?

Isetan (Singapore)'s profit was reduced by unusual items worth S$2.3m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. Isetan (Singapore) took a rather significant hit from unusual items in the year to December 2021. As a result, we can surmise that the unusual items made its statutory profit significantly weaker than it would otherwise be.

Our Take On Isetan (Singapore)'s Profit Performance

Considering both Isetan (Singapore)'s accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. After considering all this, we reckon Isetan (Singapore)'s statutory profit probably understates its earnings potential! If you'd like to know more about Isetan (Singapore) as a business, it's important to be aware of any risks it's facing. In terms of investment risks, we've identified 1 warning sign with Isetan (Singapore), and understanding this should be part of your investment process.

Our examination of Isetan (Singapore) has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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. 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. 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.