Soft earnings didn’t appear to concern IGO Limited’s (ASX:IGO) shareholders over the last week. We think that the softer headline numbers might be getting counterbalanced by some positive underlying factors.
View our latest analysis for IGO
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. This ratio tells us how much of a company’s profit is not backed by free cashflow.
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. That’s because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.
Over the twelve months to June 2024, IGO recorded an accrual ratio of -0.22. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of AU$673m, well over the AU$2.80m it reported in profit. IGO’s free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons. However, that’s not all there is to consider. 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.
IGO’s profit was reduced by unusual items worth AU$214m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we’d expect to see a strong accrual ratio, which is exactly what has happened in this case. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that’s hardly a surprise given these line items are considered unusual. IGO took a rather significant hit from unusual items in the year to June 2024. As a result, we can surmise that the unusual items made its statutory profit significantly weaker than it would otherwise be.
In conclusion, both IGO’s accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. After considering all this, we reckon IGO’s statutory profit probably understates its earnings potential! 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. You’d be interested to know, that we found 3 warning signs for IGO and you’ll want to know about them.
Our examination of IGO has focussed on certain factors that can make its earnings look better than they are. And it has passed with flying colours. 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.