Thungela Resources' (JSE:TGA) Earnings Are Weaker Than They Seem

Despite announcing strong earnings, Thungela Resources Limited's (JSE:TGA) stock was sluggish. We did some digging and found some worrying underlying problems.

View our latest analysis for Thungela Resources

Examining Cashflow Against Thungela Resources' Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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".

Over the twelve months to December 2021, Thungela Resources recorded an accrual ratio of 0.37. Ergo, its free cash flow is significantly weaker than its profit. Statistically speaking, that's a real negative for future earnings. To wit, it produced free cash flow of R3.8b during the period, falling well short of its reported profit of R6.43b. Notably, Thungela Resources had negative free cash flow last year, so the R3.8b it produced this year was a welcome improvement. 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.

How Do Unusual Items Influence Profit?

Unfortunately (in the short term) Thungela Resources saw its profit reduced by unusual items worth R1.2b. If this was a non-cash charge, it would have made the accrual ratio better, if cashflow had stayed strong, so it's not great to see in combination with an uninspiring accrual ratio. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. 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 Thungela Resources 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 Thungela Resources' Profit Performance

Thungela Resources saw unusual items weigh on its profit, which should have made it easier to show high cash conversion, which it did not do, according to its accrual ratio. Based on these factors, we think it's very unlikely that Thungela Resources' statutory profits make it seem much weaker than it is. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For instance, we've identified 4 warning signs for Thungela Resources (2 are potentially serious) you should be familiar with.

Our examination of Thungela Resources 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. 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.