Are Skyline Champion's (NYSE:SKY) 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. That said, the current statutory profit is not always a good guide to a company's underlying profitability. In this article, we'll look at how useful this year's statutory profit is, when analysing Skyline Champion (NYSE:SKY).

It's good to see that over the last twelve months Skyline Champion made a profit of US$57.0m on revenue of US$1.27b.

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Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. As a result, today we're going to take a closer look at Skyline Champion'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.

Examining Cashflow Against Skyline Champion'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. 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 December 2020, Skyline Champion had an accrual ratio of -0.12. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of US$100m during the period, dwarfing its reported profit of US$57.0m. Skyline Champion 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.

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that Skyline Champion's profit was boosted by unusual items worth US$6.3m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. 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 Skyline Champion 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 Skyline Champion's Profit Performance

Skyline Champion'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. Given the contrasting considerations, we don't have a strong view as to whether Skyline Champion's profits are an apt reflection of its underlying potential for profit. If you'd like to know more about Skyline Champion as a business, it's important to be aware of any risks it's facing. For example, we've discovered 1 warning sign that you should run your eye over to get a better picture of Skyline Champion.

Our examination of Skyline Champion has focussed on certain factors that can make its earnings look better than they are. 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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