Hainan Drinda New Energy Technology's (SZSE:002865) Sluggish Earnings Might Be Just The Beginning Of Its Problems

Hainan Drinda New Energy Technology Co., Ltd.'s (SZSE:002865) earnings announcement last week contained some soft numbers, disappointing investors. We did some digging and think there are some comforting factors lying beneath the statutory profit numbers.

Check out our latest analysis for Hainan Drinda New Energy Technology

Examining Cashflow Against Hainan Drinda New Energy Technology'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.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to March 2024, Hainan Drinda New Energy Technology recorded an accrual ratio of 0.21. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of CN¥481.4m, a look at free cash flow indicates it actually burnt through CN¥314m in the last year. We also note that Hainan Drinda New Energy Technology's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥314m. Having said that, there is more to consider. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares.

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.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, Hainan Drinda New Energy Technology increased the number of shares on issue by 15% over the last twelve months by issuing new shares. As a result, its net income is now split between a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out Hainan Drinda New Energy Technology's historical EPS growth by clicking on this link.

A Look At The Impact Of Hainan Drinda New Energy Technology's Dilution On Its Earnings Per Share (EPS)

Unfortunately, we don't have any visibility into its profits three years back, because we lack the data. Even looking at the last year, profit was still down 54%. Sadly, earnings per share fell further, down a full 58% in that time. Therefore, the dilution is having a noteworthy influence on shareholder returns.

In the long term, if Hainan Drinda New Energy Technology's earnings per share can increase, then the share price should too. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

The Impact Of Unusual Items On Profit

Hainan Drinda New Energy Technology's profit suffered from unusual items, which reduced profit by CN¥896m 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. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. Hainan Drinda New Energy Technology took a rather significant hit from unusual items in the year to March 2024. As a result, we can surmise that the unusual items made its statutory profit significantly weaker than it would otherwise be.

Our Take On Hainan Drinda New Energy Technology's Profit Performance

In conclusion, Hainan Drinda New Energy Technology's accrual ratio suggests that its statutory earnings are not backed by cash flow; but the fact unusual items actually weighed on profit may create upside if those unusual items to not recur. On top of that, the dilution means that shareholders now own less of the company. Having considered these factors, we don't think Hainan Drinda New Energy Technology'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 Hainan Drinda New Energy Technology at this point in time. For example, we've found that Hainan Drinda New Energy Technology has 4 warning signs (1 is a bit concerning!) that deserve your attention before going any further with your analysis.

Our examination of Hainan Drinda New Energy Technology 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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.