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The market wasn't impressed with the soft earnings from Olam Group Limited (SGX:VC2) recently. We did some analysis, and found that there are some reasons to be cautious about the headline numbers.
View our latest analysis for Olam Group
Zooming In On Olam Group's Earnings
One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.
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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
Olam Group has an accrual ratio of 0.27 for the year to December 2024. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In the last twelve months it actually had negative free cash flow, with an outflow of S$6.0b despite its profit of S$53.8m, mentioned above. We also note that Olam Group's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of S$6.0b.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Olam Group.
Our Take On Olam Group's Profit Performance
Olam Group didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Olam Group's true underlying earnings power is actually less than its statutory profit. In further bad news, its earnings per share decreased in the last year. 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 Olam Group at this point in time. For example, Olam Group has 5 warning signs (and 4 which are potentially serious) we think you should know about.