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Eli Lilly and Company (NYSE:LLY) just reported healthy earnings but the stock price didn't move much. We think that investors have missed some encouraging factors underlying the profit figures.
Check out our latest analysis for Eli Lilly
A Closer Look At Eli Lilly'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). To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. The ratio shows us how much a company's profit exceeds its FCF.
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.
Eli Lilly has an accrual ratio of 0.25 for the year to December 2024. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. To wit, it produced free cash flow of US$1.0b during the period, falling well short of its reported profit of US$10.6b. Given that Eli Lilly had negative free cash flow in the prior corresponding period, the trailing twelve month resul of US$1.0b would seem to be a step in the right direction. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.
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
Unfortunately (in the short term) Eli Lilly saw its profit reduced by unusual items worth US$4.2b. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. 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, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect Eli Lilly to produce a higher profit next year, all else being equal.