PNC Process Systems' (SHSE:603690) Solid Earnings May Rest On Weak Foundations

PNC Process Systems Co., Ltd.'s (SHSE:603690) robust recent earnings didn't do much to move the stock. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

Check out our latest analysis for PNC Process Systems

Zooming In On PNC Process Systems' 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. 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.

Over the twelve months to March 2024, PNC Process Systems recorded an accrual ratio of 0.26. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of CN¥378.2m, a look at free cash flow indicates it actually burnt through CN¥1.7b in the last year. We also note that PNC Process Systems' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥1.7b. 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.

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

Given the accrual ratio, it's not overly surprising that PNC Process Systems' profit was boosted by unusual items worth CN¥81m 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'. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On PNC Process Systems' Profit Performance

PNC Process Systems had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue PNC Process Systems' profits probably give an overly generous impression of its sustainable level of profitability. If you'd like to know more about PNC Process Systems as a business, it's important to be aware of any risks it's facing. Every company has risks, and we've spotted 2 warning signs for PNC Process Systems you should know about.

Our examination of PNC Process Systems 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.