Anhui Guangxin Agrochemical's (SHSE:603599) Anemic Earnings Might Be Worse Than You Think

Anhui Guangxin Agrochemical Co., Ltd.'s (SHSE:603599) recent weak earnings report didn't cause a big stock movement. We think that investors are worried about some weaknesses underlying the earnings.

See our latest analysis for Anhui Guangxin Agrochemical

Zooming In On Anhui Guangxin Agrochemical's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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.

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. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Anhui Guangxin Agrochemical has an accrual ratio of 0.48 for the year to September 2024. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of CN¥689.7m, a look at free cash flow indicates it actually burnt through CN¥288m in the last year. It's worth noting that Anhui Guangxin Agrochemical generated positive FCF of CN¥1.5b a year ago, so at least they've done it 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.

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?

Anhui Guangxin Agrochemical's profit suffered from unusual items, which reduced profit by CN¥105m in the last twelve months. If this was a non-cash charge, it would have made the accrual ratio better, if cashflow had stayed strong, so it's not great to see in combination with an uninspiring accrual ratio. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. 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. If Anhui Guangxin Agrochemical doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Anhui Guangxin Agrochemical's Profit Performance

In conclusion, Anhui Guangxin Agrochemical's accrual ratio suggests that its statutory earnings are not backed by cash flow, even though unusual items weighed on profit. Having considered these factors, we don't think Anhui Guangxin Agrochemical's statutory profits give an overly harsh view of the business. So while earnings quality is important, it's equally important to consider the risks facing Anhui Guangxin Agrochemical at this point in time. Every company has risks, and we've spotted 3 warning signs for Anhui Guangxin Agrochemical (of which 1 shouldn't be ignored!) you should know about.

Our examination of Anhui Guangxin Agrochemical 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. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.