Are La Kaffa International's (GTSM:2732) Statutory Earnings A Good Guide To Its Underlying Profitability?

As a general rule, we think profitable companies are less risky than companies that lose money. 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. In this article, we'll look at how useful this year's statutory profit is, when analysing La Kaffa International (GTSM:2732).

While La Kaffa International was able to generate revenue of NT$4.25b in the last twelve months, we think its profit result of NT$158.7m was more important. The chart below shows how it has grown revenue over the last three years, but that profit has declined.

See our latest analysis for La Kaffa 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. As a result, today we're going to take a closer look at La Kaffa International's cashflow, and unusual items, with a view to understanding what these might tell us about 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.

Zooming In On La Kaffa International's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. 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. 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.

For the year to September 2020, La Kaffa International had an accrual ratio of -0.33. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of NT$622m during the period, dwarfing its reported profit of NT$158.7m. La Kaffa International's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. 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.

The Impact Of Unusual Items On Profit

While the accrual ratio might bode well, we also note that La Kaffa International's profit was boosted by unusual items worth NT$48m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And, after all, that's exactly what the accounting terminology implies. If La Kaffa International 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 La Kaffa International's Profit Performance

La Kaffa International's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Considering all the aforementioned, we'd venture that La Kaffa International's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. If you'd like to know more about La Kaffa International as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 4 warning signs for La Kaffa International you should be aware of.

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. 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. 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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