China SpacesatLtd's (SHSE:600118) Weak Earnings Might Be Worse Than They Appear

After announcing weak earnings, China Spacesat Co.,Ltd.'s (SHSE:600118) stock was strong. While shares were up, we believe there are some factors in the earnings report that might cause investors some concerns.

Check out our latest analysis for China SpacesatLtd

A Closer Look At China SpacesatLtd's 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. 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'.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

For the year to December 2023, China SpacesatLtd had an accrual ratio of 0.28. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of CN¥157.5m, a look at free cash flow indicates it actually burnt through CN¥1.3b in the last year. We saw that FCF was CN¥113m a year ago though, so China SpacesatLtd has at least been able to generate positive FCF in the past. 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.

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.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by CN¥31m, in the last year, probably goes some way to explain why its accrual ratio was so weak. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. China SpacesatLtd had a rather significant contribution from unusual items relative to its profit to December 2023. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On China SpacesatLtd's Profit Performance

Summing up, China SpacesatLtd received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue China SpacesatLtd's profits probably give an overly generous impression of its sustainable level of profitability. So while earnings quality is important, it's equally important to consider the risks facing China SpacesatLtd at this point in time. Every company has risks, and we've spotted 2 warning signs for China SpacesatLtd (of which 1 is significant!) you should know about.

Our examination of China SpacesatLtd 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 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 that insiders are buying.

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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.