Why i3 Energy’s Healthy Income (LON: I3E) isn’t as good as it looks
Strong earnings numbers didn’t seem to be enough to please i3 Energy Plc (LON: I3E) shareholders. Our analysis suggests that they may be concerned about some underlying details.
Check out our latest review for i3 Energy
Review of cash flow versus earnings of i3 Energy
A key financial ratio used to measure how well a business converts earnings into free cash flow (FCF) is the accumulation rate. Simply put, this ratio subtracts FCF from net income and divides that number by the company’s average operating assets over that period. You could think of the accumulation ratio from cash flow as the “non FCF profit ratio”.
This means that a negative accrual ratio is a good thing, because it shows that the company is generating more free cash flow than its profits suggest. While it is not a problem to have a positive accumulation ratio, indicating a certain level of non-cash profits, a high accumulation ratio is arguably a bad thing, as it indicates that paper profits do not match. to cash flow. To quote a 2014 article by Lewellen and Resutek, “Firms with higher totals tend to be less profitable in the future.”
Over the twelve months ended December 2020, i3 Energy recorded a accrual ratio of 0.61. Statistically speaking, this is really negative for future income. And indeed, during the period, the company produced no free cash flow. Even though it reported a profit of £ 11.7million, a free cash flow review indicates that it has actually burned down £ 22million in the past year. We also note that i3 Energy’s free cash flow was negative last year as well, so we could see if shareholders were embarrassed by its £ 22million outflow. However, this is not the end of the story. We can examine the impact of unusual items in the income statement on its accrual ratio, as well as the negative impact of dilution on shareholders.
This might make you wonder what analysts are predicting in terms of future profitability. Fortunately, you can click here to see an interactive graph depicting future profitability, based on their estimates.
To understand the value of growing a company’s earnings, it is imperative to consider any dilution of shareholder interests. It turns out that i3 Energy has issued 571% more new shares in the past year. This means that its profits are distributed among a greater number of stocks. Celebrating the bottom line while ignoring the dilution is like celebrating because you only have one slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. You can see a graph of i3 Energy’s EPS by clicking here.
What is the impact of dilution on i3 Energy earnings per share? (EPS)
i3 Energy was losing money three years ago. Looking back at last year, we still can’t talk about the growth rate consistently, since it made a loss last year. But math aside, it’s always good to see when a once unprofitable business comes to fruition (although we accept that the profit would have been higher if dilution hadn’t been necessary). We can therefore see that the dilution had a fairly significant impact on the shareholders.
While i3 Energy’s EPS can increase over time, it dramatically improves the chances of the stock price moving in the same direction. But on the other hand, we’d be a lot less excited to hear that earnings (but not EPS) were improving. For the ordinary retail shareholder, EPS is an excellent metric for checking your hypothetical “share” of the company’s earnings.
The impact of unusual items on profit
Considering the build-up ratio, it’s not too surprising that i3 Energy’s profit has been boosted by unusual items worth £ 24million over the past twelve months. While it’s always nice to have higher profits, a large contribution of unusual items sometimes dampens our enthusiasm. We have analyzed the numbers for most of the listed companies in the world, and it is very common for unusual items to be unique in nature. And, after all, that’s exactly what accounting terminology implies. i3 Energy made a fairly large contribution of unusual items to its profit for December 2020. All other things being equal, this would likely make statutory profit a poor indicator of underlying profit power.
Our perspective on i3 Energy earnings performance
i3 Energy did not support earnings with free cash flow, but that’s not too surprising given that earnings were inflated by unusual items. Meanwhile, the new shares issued mean that shareholders now own less of the company, unless they contribute more money themselves. On reflection, the factors mentioned above give us a strong impression that the underlying profit power of i3 Energy is not as good as it looks, based on the statutory profit numbers. So while the quality of earnings is important, it is just as important to consider the risks that i3 Energy currently faces. Our analysis shows 4 warning signs for i3 Energy (2 are significant!) And we strongly recommend that you consult them before investing.
Our review of i3 Energy focused on some factors that can make its income better than it is. And, on that basis, we are somewhat skeptical. But there are plenty of other ways to tell your opinion about a business. For example, many people see a high return on equity as an indication of a favorable business economy, while others like to “follow the money” and look for stocks that insiders are buying. So you might want to see this free a set of companies offering a high return on equity, or that list of stocks that insiders buy.
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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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