Here's Why We Don't Think ATE Energy International's (GTSM:6179) Statutory Earnings Reflect Its Underlying Earnings Potential

Broadly speaking, profitable businesses are less risky than unprofitable ones. 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. Today we'll focus on whether this year's statutory profits are a good guide to understanding ATE Energy International (GTSM:6179).

We like the fact that ATE Energy International made a profit of NT$142.5m on its revenue of NT$2.84b, in the last year. As you can see in the chart below, its profit has declined over the last three years, even though its revenue has increased.

View our latest analysis for ATE Energy International

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we'll look at what ATE Energy International's cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of ATE Energy International.

Zooming In On ATE Energy International'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, ATE Energy International recorded an accrual ratio of 0.35. We can therefore deduce that its free cash flow fell well short of covering its statutory profit, suggesting we might want to think twice before putting a lot of weight on the latter. In the last twelve months it actually had negative free cash flow, with an outflow of NT$642m despite its profit of NT$142.5m, mentioned above. We also note that ATE Energy International's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of NT$642m.

Our Take On ATE Energy International's Profit Performance

As we have made quite clear, we're a bit worried that ATE Energy International didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that ATE Energy International's underlying earnings power is lower than its statutory profit. The good news is that, its earnings per share increased by 55% in the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. 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. Our analysis shows 5 warning signs for ATE Energy International (3 are potentially serious!) and we strongly recommend you look at them before investing.

This note has only looked at a single factor that sheds light on the nature of ATE Energy International's profit. 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 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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