Profit ratio

Cielo (BVMF:CIEL3) earnings are of dubious quality

Cielo S.A. (BVMF:CIEL3) a robust earnings report failed to move the market for its stock. Our analysis suggests that shareholders have noticed something concerning in the numbers.

See our latest analysis for Cielo

BOVESPA:CIEL3 Earnings & Revenue History May 10, 2022

Review of Cielo’s Cash Flow vs Earnings

A key financial ratio used to measure a company’s ability to convert earnings into free cash flow (FCF) is the exercise ratio. Put simply, this ratio subtracts FCF from net income and divides that number by the company’s average operating assets over that period. This ratio tells us how much of a company’s profit is not backed by free cash flow.

Therefore, a negative accrual ratio is positive for the company and a positive accrual ratio is negative. That’s not to say we should worry about a positive accumulation ratio, but it’s worth noting where the accumulation ratio is rather high. Indeed, some academic studies have suggested that high accrual ratios tend to lead to lower earnings or less earnings growth.

In the twelve months to March 2022, Cielo had an accrual rate of 0.25. Therefore, we know that his free cash flow was significantly lower than his statutory profit, which is hardly a good thing. In the past twelve months, he had actually negative free cash flow, with an outflow of R$3.0 billion despite its profit of R$923.0 million, mentioned above. It should be noted that Cielo generated a positive FCF of 1.8 billion reais a year ago, so at least they have done so in the past. A bright spot for Cielo shareholders is that its accrual ratio was significantly better last year, giving reason to believe it could revert to stronger cash conversion in the future. Therefore, some shareholders might seek a higher cash conversion in the current year.

This might make you wonder what analysts predict in terms of future profitability. Luckily, you can click here to see an interactive chart outlining future profitability, based on their estimates.

Our view on Cielo’s earnings performance

Cielo hasn’t converted much of its earnings into free cash flow over the past year, which some investors may consider rather suboptimal. For this reason, we believe that Cielo’s statutory earnings may be better than its underlying earnings capacity. But at least holders can take comfort in the 66% growth in EPS over the past year. Ultimately, it is essential to consider more than the above factors, if you want to fully understand the business. So while the quality of earnings is important, it is equally important to consider the risks that Cielo faces at this stage. Our analysis shows 2 warning signs for Cielo (1 should not be ignored!) and we strongly recommend that you consult them before investing.

This note has examined only one factor that sheds light on the nature of Cielo’s earnings. But there’s always more to discover if you’re able to focus on the details. Some people consider a high return on equity to be a good sign of a quality company. So you might want to see this free collection of companies offering a high return on equity, or this list of stocks that insiders buy.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.