Stock Analysis

We Think That There Are More Issues For Tongxing Environmental Protection TechnologyLtd (SZSE:003027) Than Just Sluggish Earnings

SZSE:003027
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The subdued market reaction suggests that Tongxing Environmental Protection Technology Co.,Ltd's (SZSE:003027) recent earnings didn't contain any surprises. We think that investors are worried about some weaknesses underlying the earnings.

View our latest analysis for Tongxing Environmental Protection TechnologyLtd

earnings-and-revenue-history
SZSE:003027 Earnings and Revenue History November 7th 2024

Zooming In On Tongxing Environmental Protection TechnologyLtd'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). 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.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to September 2024, Tongxing Environmental Protection TechnologyLtd recorded an accrual ratio of -0.15. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of CN¥239m, well over the CN¥16.9m it reported in profit. Given that Tongxing Environmental Protection TechnologyLtd had negative free cash flow in the prior corresponding period, the trailing twelve month resul of CN¥239m would seem to be a step in the right direction. However, we can see that a recent tax benefit, along with unusual items, have impacted its statutory profit, and therefore its accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Tongxing Environmental Protection TechnologyLtd.

The Impact Of Unusual Items On Profit

Surprisingly, given Tongxing Environmental Protection TechnologyLtd's accrual ratio implied strong cash conversion, its paper profit was actually boosted by CN¥13m in unusual items. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. Which is hardly surprising, given the name. We can see that Tongxing Environmental Protection TechnologyLtd'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.

An Unusual Tax Situation

In addition to the notable accrual ratio, we can see that Tongxing Environmental Protection TechnologyLtd received a tax benefit of CN¥1.5m. It's always a bit noteworthy when a company is paid by the tax man, rather than paying the tax man. Of course, prima facie it's great to receive a tax benefit. 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. Assuming the tax benefit is not repeated every year, we could see its profitability drop noticeably, all else being equal.

Our Take On Tongxing Environmental Protection TechnologyLtd's Profit Performance

In conclusion, Tongxing Environmental Protection TechnologyLtd's accrual ratio suggests its earnings are well backed by cash but its boost from unusual items, and a tax benefit, probably mean that the statutory number make the company seem more profitable than it is at an underlying level. After taking into account all the aforementioned observations we think that Tongxing Environmental Protection TechnologyLtd's profits probably give a generous impression of its sustainable level of profitability. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. To that end, you should learn about the 3 warning signs we've spotted with Tongxing Environmental Protection TechnologyLtd (including 1 which doesn't sit too well with us).

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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.