Shareholders seemed unconcerned about The (SGX:U09) delivered a lackluster earnings report last week. Our analysis suggests that while earnings are weak, the company’s fundamentals are strong.
Check out our latest analysis for Avarga
Looking at cash flow versus Avarga’s earnings
Many investors have never heard of the Accrual ratio from cash flowbut it is actually a useful measure of how well a company’s profit is covered by its free cash flow (FCF) during a given period. The accrual ratio subtracts FCF from profit for a given period and divides the result by the company’s average funds from operations during that period. The ratio tells us how much a company’s profit exceeds its FCF.
This means that a negative accrual ratio is a good thing because it shows that the company is generating more free cash flow than its earnings would suggest. While an accrual ratio above zero is of little concern, we think it is noteworthy when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, “Companies with higher accruals tend to be less profitable in the future.”
For the twelve months to June 2024, Avarga recorded an accrual ratio of -0.14. This means that the company has very good cash conversion and that its earnings over the last year actually significantly underestimate its free cash flow. That is to say, it generated free cash flow of S$69m in that period, dwarfing its reported profit of S$9.09m. Avarga’s free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. However, there’s more to the story. We can see that unusual items have impacted its statutory profit and therefore the accrual ratio.
Note: We always recommend investors check balance sheet strength. Click here to access our balance sheet analysis of Avarga.
How do unusual items affect profits?
Avarga’s profit was hurt by S$15 million worth of unusual items over the last twelve months, which helped the company achieve high cash conversion, which is reflected in the unusual items. In a scenario where these unusual items included non-cash costs, we would expect a strong provisioning ratio, and that is exactly what happened in this case. It’s never nice when unusual items cost the company profits, but the bright side is that things could improve sooner rather than later. When we analyzed the vast majority of listed companies globally, we found that significant unusual items are often non-recurring. And that is exactly what the accounting terminology implies. If these unusual expenses are non-recurring at Avarga, all other things being equal, we would expect its profit to increase in the coming year.
Our assessment of Avarga’s earnings development
Given Avarga’s accrual ratio and unusual items, we think it’s unlikely that statutory profits overstate the company’s underlying earnings power. Based on these factors, we believe Avarga’s earnings potential is at least as good as it seems, and maybe even better! So if you want to dig deeper into this stock, it’s important to consider all the risks it faces. To help you do that, here’s what we’ve found: 3 warning signs (1 is potentially serious!) that you should know before buying shares of Avarga.
After examining the nature of Avarga’s earnings, we are bullish on the company. However, there are many other ways to form an opinion about a company. For example, many people look to a high return on equity as an indication of favorable business conditions, while others like to “follow the money” and look for stocks that insiders are buying. You may want to check this out. free Collection of companies with high return on equity or this list of stocks with high insider ownership.
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This Simply Wall St article is of a general nature. We comment solely on the basis of historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.
