HNA TechnologyLtd (SHSE:600751) Strong Profits May Be Masking Some Underlying Issues

HNA Technology Co.,Ltd.'s (SHSE:600751) healthy profit numbers didn't contain any surprises for investors. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.

Check out our latest analysis for HNA TechnologyLtd

Zooming In On HNA TechnologyLtd'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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 it's not a problem to have a positive accrual ratio, indicating a certain level of non-cash profits, a high accrual ratio is arguably a bad thing, because it indicates paper profits are not matched by cash flow. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

HNA TechnologyLtd has an accrual ratio of 0.96 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. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥2.3b despite its profit of CN¥277.5m, mentioned above. We also note that HNA TechnologyLtd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥2.3b.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of HNA TechnologyLtd.

Our Take On HNA TechnologyLtd's Profit Performance

As we discussed above, we think HNA TechnologyLtd's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that HNA TechnologyLtd's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. But the happy news is that, while acknowledging we have to look beyond the statutory numbers, those numbers are still improving, with EPS growing at a very high rate over 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 while earnings quality is important, it's equally important to consider the risks facing HNA TechnologyLtd at this point in time. Be aware that HNA TechnologyLtd is showing 2 warning signs in our investment analysis and 1 of those is significant...

Today we've zoomed in on a single data point to better understand the nature of HNA TechnologyLtd'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.