Vaccitech's (NASDAQ:VACC) Earnings Are Of Questionable Quality

Vaccitech plc (NASDAQ:VACC) just reported some strong earnings, and the market reacted accordingly with a healthy uplift in the share price. However, our analysis suggests that shareholders may be missing some factors that indicate the earnings result was not as good as it looked.

Check out the opportunities and risks within the US Biotechs industry.

Zooming In On Vaccitech'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). In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Vaccitech has an accrual ratio of 1.08 for the year to September 2022. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of US$17m, in contrast to the aforementioned profit of US$11.4m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of US$17m, this year, indicates high risk. Having said that, there is more to consider. We can look at how unusual items in the profit and loss statement impacted its accrual ratio, as well as explore how dilution is impacting shareholders negatively.

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.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. Vaccitech expanded the number of shares on issue by 7.0% over the last year. Therefore, each share now receives a smaller portion of profit. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. You can see a chart of Vaccitech's EPS by clicking here.

A Look At The Impact Of Vaccitech's Dilution On Its Earnings Per Share (EPS)

Unfortunately, we don't have any visibility into its profits three years back, because we lack the data. And even focusing only on the last twelve months, we don't have a meaningful growth rate because it made a loss a year ago, too. But mathematics aside, it is always good to see when a formerly unprofitable business come good (though we accept profit would have been higher if dilution had not been required). And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, if Vaccitech's earnings per share can increase, then the share price should too. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

How Do Unusual Items Influence Profit?

Unfortunately (in the short term) Vaccitech saw its profit reduced by unusual items worth US$943k. 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, after all, that's exactly what the accounting terminology implies. If Vaccitech doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Vaccitech's Profit Performance

Summing up, Vaccitech's unusual items suggest that its statutory earnings were temporarily depressed, and its accrual ratio indicates a lack of free cash flow relative to profit. On top of that, the dilution means that shareholders now own less of the company. After taking into account all the aforementioned observations we think that Vaccitech's profits probably give a generous impression of its sustainable level of profitability. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. Be aware that Vaccitech is showing 5 warning signs in our investment analysis and 2 of those make us uncomfortable...

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.