Shareholders were pleased with the recent earnings report from Santacruz Silver Mining Ltd. (CVE:SCZ). Despite this, we feel that there are some reasons to be cautious with these earnings.
Check out our latest analysis for Santacruz Silver Mining
Examining Cashflow Against Santacruz Silver Mining’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. 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. 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”.
Over the twelve months to December 2023, Santacruz Silver Mining recorded an accrual ratio of 0.81. That means it didn’t generate anywhere near enough free cash flow to match its profit. Statistically speaking, that’s a real negative for future earnings. Indeed, in the last twelve months it reported free cash flow of US$8.1m, which is significantly less than its profit of US$16.1m. Santacruz Silver Mining shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months. 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. The good news for shareholders is that Santacruz Silver Mining’s accrual ratio was much better last year, so this year’s poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Santacruz Silver Mining.
How Do Unusual Items Influence Profit?
The fact that the company had unusual items boosting profit by US$13m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. We can see that Santacruz Silver Mining’s positive unusual items were quite significant relative to its profit in the year to December 2023. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.
Our Take On Santacruz Silver Mining’s Profit Performance
Santacruz Silver Mining had a weak accrual ratio, but its profit did receive a boost from unusual items. For all the reasons mentioned above, we think that, at a glance, Santacruz Silver Mining’s statutory profits could be considered to be low quality, because they are likely to give investors an overly positive impression of the company. So while earnings quality is important, it’s equally important to consider the risks facing Santacruz Silver Mining at this point in time. When we did our research, we found 4 warning signs for Santacruz Silver Mining (2 are a bit unpleasant!) that we believe deserve your full attention.
Our examination of Santacruz Silver Mining has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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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Find out whether Santacruz Silver Mining is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.
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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.