CECO Environmental's (NASDAQ:CECO) Soft Earnings Don't Show The Whole Picture

Investors were disappointed with the weak earnings posted by CECO Environmental Corp. (NASDAQ:CECO ). Despite the soft profit numbers, our analysis has optimistic about the overall quality of the income statement.

Check out our latest analysis for CECO Environmental

A Closer Look At CECO Environmental'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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to March 2024, CECO Environmental recorded an accrual ratio of -0.11. Therefore, its statutory earnings were quite a lot less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of US$49m, well over the US$12.4m it reported in profit. CECO Environmental shareholders are no doubt pleased that free cash flow improved over the last twelve months. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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.

The Impact Of Unusual Items On Profit

CECO Environmental's profit was reduced by unusual items worth US$5.5m 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. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect CECO Environmental to produce a higher profit next year, all else being equal.

Our Take On CECO Environmental's Profit Performance

In conclusion, both CECO Environmental's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think CECO Environmental's earnings potential is at least as good as it seems, and maybe even better! So while earnings quality is important, it's equally important to consider the risks facing CECO Environmental at this point in time. At Simply Wall St, we found 2 warning signs for CECO Environmental and we think they deserve your attention.

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