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Shareholders appeared unconcerned with Woolworths Group Limited's (ASX:WOW) lackluster earnings report last week. We did some digging, and we believe the earnings are stronger than they seem.
See our latest analysis for Woolworths Group
A Closer Look At Woolworths Group'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 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.
For the year to June 2024, Woolworths Group had an accrual ratio of -0.19. Therefore, its statutory earnings were very significantly less than its free cashflow. In fact, it had free cash flow of AU$1.8b in the last year, which was a lot more than its statutory profit of AU$108.0m. Woolworths Group did see its free cash flow drop year on year, which is less than ideal, like a Simpson's episode without Groundskeeper Willie.
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.
Our Take On Woolworths Group's Profit Performance
Happily for shareholders, Woolworths Group produced plenty of free cash flow to back up its statutory profit numbers. Because of this, we think Woolworths Group's underlying earnings potential is as good as, or possibly even better, than the statutory profit makes it seem! On the other hand, its EPS actually shrunk in the last twelve months. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So while earnings quality is important, it's equally important to consider the risks facing Woolworths Group at this point in time. For example, Woolworths Group has 3 warning signs (and 1 which can't be ignored) we think you should know about.