Shanghai Automobile Air-Conditioner Accessories' (SHSE:603107) Shareholders Have More To Worry About Than Only Soft Earnings

A lackluster earnings announcement from Shanghai Automobile Air-Conditioner Accessories Co., Ltd. (SHSE:603107) last week didn't sink the stock price. We think that investors are worried about some weaknesses underlying the earnings.

Check out our latest analysis for Shanghai Automobile Air-Conditioner Accessories

Examining Cashflow Against Shanghai Automobile Air-Conditioner Accessories' Earnings

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. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. 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 2024, Shanghai Automobile Air-Conditioner Accessories had an accrual ratio of 0.25. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of CN¥170.6m, a look at free cash flow indicates it actually burnt through CN¥126m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥126m, this year, indicates high risk. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shanghai Automobile Air-Conditioner Accessories.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Shanghai Automobile Air-Conditioner Accessories' profit was boosted by unusual items worth CN¥21m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's as you'd expect, given these boosts are described as 'unusual'. If Shanghai Automobile Air-Conditioner Accessories doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Shanghai Automobile Air-Conditioner Accessories' Profit Performance

Shanghai Automobile Air-Conditioner Accessories had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Shanghai Automobile Air-Conditioner Accessories' profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into Shanghai Automobile Air-Conditioner Accessories, you'd also look into what risks it is currently facing. Every company has risks, and we've spotted 2 warning signs for Shanghai Automobile Air-Conditioner Accessories (of which 1 is concerning!) you should know about.

Our examination of Shanghai Automobile Air-Conditioner Accessories has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.