Beyond Lackluster Earnings: Potential Concerns For Hunan Corun New Energy's (SHSE:600478) Shareholders

After announcing weak earnings, Hunan Corun New Energy Co., Ltd.'s (SHSE:600478) stock was strong. Despite the market responding positively, we think that there are several concerning factors that investors should be aware of.

View our latest analysis for Hunan Corun New Energy

A Closer Look At Hunan Corun New Energy's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Hunan Corun New Energy has an accrual ratio of 0.25 for the year to September 2023. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Even though it reported a profit of CN¥35.7m, a look at free cash flow indicates it actually burnt through CN¥1.0b in the last year. We saw that FCF was CN¥275m a year ago though, so Hunan Corun New Energy has at least been able to generate positive FCF in the past. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part. One positive for Hunan Corun New Energy shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hunan Corun New Energy.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by CN¥45m, 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'. Hunan Corun New Energy had a rather significant contribution from unusual items relative to its profit to September 2023. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Hunan Corun New Energy's Profit Performance

Summing up, Hunan Corun New Energy received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For the reasons mentioned above, we think that a perfunctory glance at Hunan Corun New Energy's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Hunan Corun New Energy as a business, it's important to be aware of any risks it's facing. To that end, you should learn about the 3 warning signs we've spotted with Hunan Corun New Energy (including 2 which shouldn't be ignored).

Our examination of Hunan Corun New Energy 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. 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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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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.