Impressive Earnings May Not Tell the Whole Story for Altitude Group (LON:ALT)

Altitude Group (LON:ALT) has recently captured investor attention with its reported earnings growth, including a 23% year-over-year revenue increase to £26.1 million and a net profit margin of 3.2% for the 2024 fiscal year. However, a closer examination of the company's financials reveals a more nuanced picture. While the headline numbers are impressive, unusual items, tax benefits, and weak profitability metrics like Return on Equity (ROE) and Return on Capital Employed (ROCE) raise questions about the sustainability of these gains.

The Distortion of Unusual Items

Altitude Group's earnings for the trailing twelve months ending March 31, 2025, included a one-off loss of $414,000, attributed to non-operational or extraordinary events. Such charges, though non-recurring, can temporarily depress reported profitability and create the illusion of weaker performance. Conversely, the company also benefited from a $765,000 tax credit in 2025, which analysts caution may not recur. This duality highlights the importance of adjusting for non-recurring items when assessing Altitude's core earnings power.

For instance, the company's adjusted operating profit rose 13.3% to £1.2 million in the six months ending September 30, 2024, despite £98,000 in exceptional charges. While this suggests resilience, the absence of recurring gains means future earnings could face downward pressure if the tax credit or one-off losses are not replicated. Investors should scrutinize the adjusted operating profit metric, which strips out these distortions, to gauge true operational performance.

Tax Benefits: A Double-Edged Sword

The UK's generous R&D tax relief regime has likely provided Altitude Group with a competitive edge. Under the merged R&D scheme introduced in 2024, companies can claim a 20% gross taxable credit on qualifying R&D costs, with net benefits of 15% for profitable firms and 16.2% for loss-making ones. If Altitude qualifies as an R&D-intensive SME (with at least 30% of expenditure on R&D), it could access even higher rates—14.5% credit and 27% cash benefits.

However, these benefits are contingent on sustained R&D investment and adherence to HMRC's stringent documentation requirements. The company's ability to maintain these incentives depends on its future R&D spending and regulatory compliance. Additionally, the negative effective tax rate of -182.01% in FY 2024—a result of a £0.708 million tax credit—was an outlier. Such anomalies may not persist, and investors should model scenarios where tax benefits normalize.

Weak ROE and ROCE: A Red Flag for Efficiency

Despite the earnings growth, Altitude Group's ROE of 6.7% and ROCE of 3.8% (as of March 2025) lag significantly behind the Software industry averages of 9.9% and 12%, respectively. These metrics measure how effectively the company generates profits from shareholders' equity and capital employed. A low ROE suggests that Altitude is underutilizing equity to drive returns, while a weak ROCE indicates inefficient capital allocation.

The decline in ROCE from 3.4% in March 2024 to 3.8% in March 2025, though marginal, is partly attributed to increased reliance on current liabilities (now funding 33% of the business). While this strategy improves liquidity, it also raises concerns about long-term solvency if short-term debt costs rise. Investors should monitor the debt-to-equity ratio and current ratio to assess whether Altitude's capital structure remains sustainable.

The Path Forward: Caution and Opportunity

Altitude Group's earnings growth is undeniably impressive, with a five-year CAGR of 83.4% and a net profit margin improvement from 2.9% to 3.2%. However, the sustainability of these gains hinges on several factors:
1. Recurring Tax Benefits: Can Altitude maintain its R&D tax credits and avoid one-off losses?
2. Operational Efficiency: Will the company improve ROE and ROCE through better capital allocation or cost management?
3. Debt Management: How will it handle its growing reliance on short-term liabilities?

For now, the stock trades at a trailing P/E of 16.75 and a forward P/E of 12.35, suggesting it is reasonably valued. However, the 38.24% decline in the past 52 weeks reflects market skepticism about its fundamentals. Investors with a long-term horizon may find value in Altitude's reinvestment strategy—its decision to retain all profits rather than pay dividends has fueled growth. Yet, those prioritizing stability should wait for clearer signals of improved profitability metrics.

Conclusion

Altitude Group's earnings story is a mix of promise and peril. While its revenue and adjusted EBITDA growth are commendable, the presence of non-recurring items, reliance on tax benefits, and weak ROE/ROCE metrics suggest that the company's earnings may not be as sustainable as they appear. Investors should approach with caution, focusing on adjusted metrics and monitoring the company's ability to improve capital efficiency. For now, Altitude Group remains a speculative bet rather than a core holding.