Hubei Heyuan GasLtd's (SZSE:002971) Profits May Not Reveal Underlying Issues

The recent earnings posted by Hubei Heyuan Gas Co.,Ltd. (SZSE:002971) were solid, but the stock didn't move as much as we expected. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

See our latest analysis for Hubei Heyuan GasLtd

Examining Cashflow Against Hubei Heyuan GasLtd'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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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".

Hubei Heyuan GasLtd has an accrual ratio of 0.30 for the year to March 2024. 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. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥565m despite its profit of CN¥83.3m, mentioned above. We also note that Hubei Heyuan GasLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥565m.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hubei Heyuan GasLtd.

Our Take On Hubei Heyuan GasLtd's Profit Performance

Hubei Heyuan GasLtd's accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Therefore, it seems possible to us that Hubei Heyuan GasLtd's true underlying earnings power is actually less than its statutory profit. The good news is that its earnings per share increased slightly in the last year. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Case in point: We've spotted 3 warning signs for Hubei Heyuan GasLtd you should be aware of.

This note has only looked at a single factor that sheds light on the nature of Hubei Heyuan GasLtd's profit. 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.