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After announcing healthy earnings, Gateway Real Estate AG’s (ETR:GTY) stock rose over the last week. However, we think that shareholders should be aware of some other factors beyond the profit numbers.
Check out our latest analysis for Gateway Real Estate
One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company’s average operating assets over that 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. That is not intended to imply we should worry about a positive accrual ratio, but it’s worth noting where the accrual ratio is rather high. To quote a 2014 paper by Lewellen and Resutek, “firms with higher accruals tend to be less profitable in the future”.
Over the twelve months to September 2024, Gateway Real Estate recorded an accrual ratio of 0.22. Unfortunately, that means its free cash flow fell significantly short of its reported profits. In the last twelve months it actually had negative free cash flow, with an outflow of €29m despite its profit of €213.7m, mentioned above. We also note that Gateway Real Estate’s free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of €29m. However, that’s not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Gateway Real Estate.
The fact that the company had unusual items boosting profit by €83m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While it’s always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. We ran the numbers on most publicly listed companies worldwide, and it’s very common for unusual items to be once-off in nature. Which is hardly surprising, given the name. We can see that Gateway Real Estate’s positive unusual items were quite significant relative to its profit in the year to September 2024. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.
