Some Investors May Be Willing To Look Past Kumba Iron Ore's (JSE:KIO) Soft Earnings

Kumba Iron Ore Limited's (JSE:KIO) stock was strong despite it releasing a soft earnings report last week. However, we think the company is showing some signs that things are more promising than they seem.

See our latest analysis for Kumba Iron Ore

Zooming In On Kumba Iron Ore'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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 having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Kumba Iron Ore has an accrual ratio of -0.15 for the year to December 2024. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of R23b during the period, dwarfing its reported profit of R14.7b. Kumba Iron Ore's free cash flow improved over the last year, which is generally good to see. 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

While the accrual ratio might bode well, we also note that Kumba Iron Ore's profit was boosted by unusual items worth R3.3b in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. If Kumba Iron Ore 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 Kumba Iron Ore's Profit Performance

In conclusion, Kumba Iron Ore's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. After taking into account all these factors, we think that Kumba Iron Ore's statutory results are a decent reflection of its underlying earnings power. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. At Simply Wall St, we found 1 warning sign for Kumba Iron Ore and we think they deserve your attention.

Our examination of Kumba Iron Ore has focussed on certain factors that can make its earnings look better than they are. 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.