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The most recent earnings report from Levi Strauss & Co. (NYSE:LEVI) was disappointing for shareholders. Despite the soft profit numbers, our analysis has optimistic about the overall quality of the income statement.
Check out our latest analysis for Levi Strauss
Examining Cashflow Against Levi Strauss' Earnings
Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
Levi Strauss has an accrual ratio of -0.19 for the year to August 2024. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of US$633m, well over the US$154.9m it reported in profit. Given that Levi Strauss had negative free cash flow in the prior corresponding period, the trailing twelve month resul of US$633m would seem to be a step in the right direction. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.
That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.
How Do Unusual Items Influence Profit?
Levi Strauss' profit was reduced by unusual items worth US$329m 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. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. In the twelve months to August 2024, Levi Strauss had a big unusual items expense. All else being equal, this would likely have the effect of making the statutory profit look worse than its underlying earnings power.