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Delorean Corporation Limited's (ASX:DEL) strong earnings report was rewarded with a positive stock price move. We did some digging and found some further encouraging factors that investors will like.
See our latest analysis for Delorean
A Closer Look At Delorean'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. 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".
For the year to June 2024, Delorean had an accrual ratio of -0.31. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of AU$6.9m during the period, dwarfing its reported profit of AU$4.77m. Given that Delorean had negative free cash flow in the prior corresponding period, the trailing twelve month resul of AU$6.9m would seem to be a step in the right direction. Importantly, we note an unusual tax situation, which we discuss below, has impacted the accruals ratio.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Delorean.
An Unusual Tax Situation
In addition to the notable accrual ratio, we can see that Delorean received a tax benefit of AU$1.3m. This is meaningful because companies usually pay tax rather than receive tax benefits. The receipt of a tax benefit is obviously a good thing, on its own. And since it previously lost money, it may well simply indicate the realisation of past tax losses. However, the devil in the detail is that these kind of benefits only impact in the year they are booked, and are often one-off in nature. In the likely event the tax benefit is not repeated, we'd expect to see its statutory profit levels drop, at least in the absence of strong growth.
Our Take On Delorean's Profit Performance
In conclusion, Delorean has strong cashflow relative to earnings, which indicates good quality earnings, but the tax benefit means its profit wasn't as sustainable as we'd like to see. Considering all the aforementioned, we'd venture that Delorean's profit result is a pretty good guide to its true profitability, albeit a bit on the conservative side. 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. Case in point: We've spotted 2 warning signs for Delorean you should be mindful of and 1 of them is a bit unpleasant.