Dalian Zhiyun Automation's (SZSE:300097) Promising Earnings May Rest On Soft Foundations

Despite posting some strong earnings, the market for Dalian Zhiyun Automation Co., Ltd.'s (SZSE:300097) stock hasn't moved much. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.

Check out our latest analysis for Dalian Zhiyun Automation

Zooming In On Dalian Zhiyun Automation'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. 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.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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 December 2023, Dalian Zhiyun Automation had an accrual ratio of 0.29. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Over the last year it actually had negative free cash flow of CN¥60m, in contrast to the aforementioned profit of CN¥140.0m. We also note that Dalian Zhiyun Automation's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥60m. However, we can see that a recent tax benefit, along with unusual items, have impacted its statutory profit, and therefore its accrual ratio. The good news for shareholders is that Dalian Zhiyun Automation's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. 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 Dalian Zhiyun Automation.

How Do Unusual Items Influence Profit?

Dalian Zhiyun Automation's profit suffered from unusual items, which reduced profit by CN¥28m in the last twelve months. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. In the twelve months to December 2023, Dalian Zhiyun Automation had a big unusual items expense. As a result, we can surmise that the unusual items made its statutory profit significantly weaker than it would otherwise be.

An Unusual Tax Situation

In addition to the notable accrual ratio, we can see that Dalian Zhiyun Automation received a tax benefit of CN¥11m. This is meaningful because companies usually pay tax rather than receive tax benefits. We're sure the company was pleased with its tax benefit. And since it previously lost money, it may well simply indicate the realisation of past tax losses. However, the devil in the detail is that these kind of benefits only impact in the year they are booked, and are often one-off in nature. In the likely event the tax benefit is not repeated, we'd expect to see its statutory profit levels drop, at least in the absence of strong growth.

Our Take On Dalian Zhiyun Automation's Profit Performance

In conclusion, Dalian Zhiyun Automation's accrual ratio suggests that its statutory earnings are not backed by cash flow, in part due to the tax benefit it received; but the fact unusual items actually weighed on profit may create upside if those unusual items do not recur. After taking into account all the aforementioned observations we think that Dalian Zhiyun Automation's profits probably give a generous impression of its sustainable level of profitability. If you want to do dive deeper into Dalian Zhiyun Automation, you'd also look into what risks it is currently facing. For example, we've discovered 2 warning signs that you should run your eye over to get a better picture of Dalian Zhiyun Automation.

Our examination of Dalian Zhiyun Automation 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. 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 that insiders are buying to be useful.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.