Stock Analysis

We Think AeroVironment's (NASDAQ:AVAV) Statutory Profit Might Understate Its Earnings Potential

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NasdaqGS:AVAV
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Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. 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. Today we'll focus on whether this year's statutory profits are a good guide to understanding AeroVironment (NASDAQ:AVAV).

It's good to see that over the last twelve months AeroVironment made a profit of US$28.9m on revenue of US$377.2m. As you can see in the chart below, its profit has declined over the last three years, even though its revenue has increased.

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earnings-and-revenue-history
NasdaqGS:AVAV Earnings and Revenue History December 24th 2020

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. Today, we'll discuss AeroVironment's free cashflow relative to its earnings, and consider what that tells us about the company. 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 AeroVironment'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). The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. 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. 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 October 2020, AeroVironment had an accrual ratio of -0.19. That indicates that its free cash flow quite significantly exceeded its statutory profit. In fact, it had free cash flow of US$65m in the last year, which was a lot more than its statutory profit of US$28.9m. AeroVironment's free cash flow improved over the last year, which is generally good to see.

Our Take On AeroVironment's Profit Performance

As we discussed above, AeroVironment'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 AeroVironment's statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over 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. If you want to do dive deeper into AeroVironment, you'd also look into what risks it is currently facing. Case in point: We've spotted 2 warning signs for AeroVironment you should be aware of.

This note has only looked at a single factor that sheds light on the nature of AeroVironment's profit. But there are plenty of other ways to inform your opinion of a company. 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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What are the risks and opportunities for AeroVironment?

AeroVironment, Inc. designs, develops, produces, delivers, and supports a portfolio of robotic systems and related services for government agencies and businesses in the United States and internationally.

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Rewards

  • Trading at 57.1% below our estimate of its fair value

  • Earnings are forecast to grow 147.8% per year

Risks

  • Significant insider selling over the past 3 months

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