ChengDu ShengNuo BiotecLtd (SHSE:688117) Strong Profits May Be Masking Some Underlying Issues

ChengDu ShengNuo Biotec Co.,Ltd. (SHSE:688117) just released a solid earnings report, and the stock displayed some strength. While the profit numbers were good, our analysis has found some concerning factors that shareholders should be aware of.

Check out our latest analysis for ChengDu ShengNuo BiotecLtd

A Closer Look At ChengDu ShengNuo BiotecLtd's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

ChengDu ShengNuo BiotecLtd has an accrual ratio of 0.39 for the year to March 2024. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of CN¥72.8m, a look at free cash flow indicates it actually burnt through CN¥221m in the last year. We also note that ChengDu ShengNuo BiotecLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥221m.

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.

Our Take On ChengDu ShengNuo BiotecLtd's Profit Performance

As we have made quite clear, we're a bit worried that ChengDu ShengNuo BiotecLtd didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that ChengDu ShengNuo BiotecLtd's underlying earnings power is lower than its statutory profit. But at least holders can take some solace from the 12% EPS growth in the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Be aware that ChengDu ShengNuo BiotecLtd is showing 2 warning signs in our investment analysis and 1 of those is a bit unpleasant...

This note has only looked at a single factor that sheds light on the nature of ChengDu ShengNuo BiotecLtd's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 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.