We Think That There Are Some Issues For NL Industries (NYSE:NL) Beyond Its Promising Earnings

The market for NL Industries, Inc.'s (NYSE:NL) stock was strong after it released a healthy earnings report last week. While the profit numbers were good, our analysis has found some concerning factors that shareholders should be aware of.

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A Closer Look At NL Industries' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. 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 June 2025, NL Industries recorded an accrual ratio of 0.36. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. Over the last year it actually had negative free cash flow of US$40m, in contrast to the aforementioned profit of US$53.6m. It's worth noting that NL Industries generated positive FCF of US$37m a year ago, so at least they've done it in the past. Having said that it seems that a recent tax benefit and some unusual items have impacted its profit (and this its accrual ratio). The good news for shareholders is that NL Industries' accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

View our latest analysis for NL Industries

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of NL Industries.

The Impact Of Unusual Items On Profit

NL Industries' profit suffered from unusual items, which reduced profit by US$2.8m in the last twelve months. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. 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 that's hardly a surprise given these line items are considered unusual. If NL Industries doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

An Unusual Tax Situation

Moving on from the accrual ratio, we note that NL Industries profited from a tax benefit which contributed US$7.8m to profit. It's always a bit noteworthy when a company is paid by the tax man, rather than paying the tax man. Of course, prima facie it's great to receive a tax benefit. However, our data indicates that tax benefits can temporarily boost statutory profit in the year it is booked, but subsequently profit may fall back. In the likely event the tax benefit is not repeated, we'd expect to see its statutory profit levels drop, at least in the absence of strong growth.

Our Take On NL Industries' Profit Performance

In conclusion, NL Industries' accrual ratio suggests that its statutory earnings are not backed by cash flow, in part due to the tax benefit it received; but the fact unusual items actually weighed on profit may create upside if those unusual items do not recur. For the reasons mentioned above, we think that a perfunctory glance at NL Industries' statutory profits might make it look better than it really is on an underlying level. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Our analysis shows 2 warning signs for NL Industries (1 is a bit unpleasant!) and we strongly recommend you look at them before investing.

Our examination of NL Industries has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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 with high insider ownership.

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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.