There May Be Underlying Issues With The Quality Of Jiangsu Seagull Cooling TowerLtd's (SHSE:603269) Earnings

Last week's profit announcement from Jiangsu Seagull Cooling Tower Co.,Ltd. (SHSE:603269) was underwhelming for investors, despite headline numbers being robust. We think that the market might be paying attention to some underlying factors that they find to be concerning.

View our latest analysis for Jiangsu Seagull Cooling TowerLtd

A Closer Look At Jiangsu Seagull Cooling TowerLtd's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. 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. 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.

For the year to September 2024, Jiangsu Seagull Cooling TowerLtd had an accrual ratio of -0.16. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of CN¥233m during the period, dwarfing its reported profit of CN¥88.7m. Jiangsu Seagull Cooling TowerLtd's free cash flow improved over the last year, which is generally good to see. 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?

While the accrual ratio might bode well, we also note that Jiangsu Seagull Cooling TowerLtd's profit was boosted by unusual items worth CN¥34m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. 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, after all, that's exactly what the accounting terminology implies. We can see that Jiangsu Seagull Cooling TowerLtd's positive unusual items were quite significant relative to its profit in the year to September 2024. 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 Jiangsu Seagull Cooling TowerLtd's Profit Performance

In conclusion, Jiangsu Seagull Cooling TowerLtd's accrual ratio suggests its statutory earnings are of good quality, but on the other hand the profits were boosted by unusual items. Based on these factors, we think it's very unlikely that Jiangsu Seagull Cooling TowerLtd's statutory profits make it seem much weaker than it is. So while earnings quality is important, it's equally important to consider the risks facing Jiangsu Seagull Cooling TowerLtd at this point in time. For example, we've discovered 2 warning signs that you should run your eye over to get a better picture of Jiangsu Seagull Cooling TowerLtd.

Our examination of Jiangsu Seagull Cooling TowerLtd has focussed on certain factors that can make its earnings look better than they are. 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. 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 with significant insider holdings 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.