Earnings Troubles May Signal Larger Issues for Guangzhou Guanggang Gases & EnergyLtd (SHSE:688548) Shareholders

Guangzhou Guanggang Gases & Energy Co.,Ltd.'s (SHSE:688548) 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 Guangzhou Guanggang Gases & EnergyLtd

Zooming In On Guangzhou Guanggang Gases & EnergyLtd'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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to September 2024, Guangzhou Guanggang Gases & EnergyLtd had an accrual ratio of 0.23. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of CN¥274.0m, a look at free cash flow indicates it actually burnt through CN¥1.0b in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥1.0b, this year, indicates high risk. 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.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by CN¥21m, in the last year, probably goes some way to explain why its accrual ratio was so weak. 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. If Guangzhou Guanggang Gases & EnergyLtd doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Guangzhou Guanggang Gases & EnergyLtd's Profit Performance

Summing up, Guangzhou Guanggang Gases & EnergyLtd received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Guangzhou Guanggang Gases & EnergyLtd's profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into Guangzhou Guanggang Gases & EnergyLtd, you'd also look into what risks it is currently facing. When we did our research, we found 2 warning signs for Guangzhou Guanggang Gases & EnergyLtd (1 can't be ignored!) that we believe deserve your full attention.

Our examination of Guangzhou Guanggang Gases & EnergyLtd 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 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.