The market seemed underwhelmed by last week's earnings announcement from Axita Cotton Limited (NSE:AXITA) despite the healthy numbers. We did some digging, and we think that investors are missing some encouraging factors in the underlying numbers.
Zooming In On Axita Cotton'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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.
Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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 September 2026, Axita Cotton had an accrual ratio of -0.36. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of ₹314m during the period, dwarfing its reported profit of ₹93.7m. Given that Axita Cotton had negative free cash flow in the prior corresponding period, the trailing twelve month resul of ₹314m would seem to be a step in the right direction. 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.
See our latest analysis for Axita Cotton
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Axita Cotton.
The Impact Of Unusual Items On Profit
Axita Cotton's profit was reduced by unusual items worth ₹25m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. If Axita Cotton doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.
Our Take On Axita Cotton's Profit Performance
In conclusion, both Axita Cotton's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think Axita Cotton's underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! If you want to do dive deeper into Axita Cotton, you'd also look into what risks it is currently facing. Be aware that Axita Cotton is showing 3 warning signs in our investment analysis and 1 of those is concerning...
After our examination into the nature of Axita Cotton's profit, we've come away optimistic for the company. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.
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