KHD Humboldt Wedag International's (ETR:KWG) Earnings May Just Be The Starting Point

KHD Humboldt Wedag International AG's (ETR:KWG) robust earnings report didn't manage to move the market for its stock. We did some digging, and we found some concerning factors in the details.

View our latest analysis for KHD Humboldt Wedag International

Examining Cashflow Against KHD Humboldt Wedag International'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'.

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. 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. 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 December 2023, KHD Humboldt Wedag International recorded an accrual ratio of -0.20. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of €14m during the period, dwarfing its reported profit of €4.28m. Notably, KHD Humboldt Wedag International had negative free cash flow last year, so the €14m it produced this year was a welcome improvement. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of KHD Humboldt Wedag International.

The Impact Of Unusual Items On Profit

While the accrual ratio might bode well, we also note that KHD Humboldt Wedag International's profit was boosted by unusual items worth €566k in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. 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. And that's as you'd expect, given these boosts are described as 'unusual'. We can see that KHD Humboldt Wedag International's positive unusual items were quite significant relative to its profit in the year to December 2023. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On KHD Humboldt Wedag International's Profit Performance

KHD Humboldt Wedag International's profits got a boost from unusual items, which indicates they might not be sustained and yet its accrual ratio still indicated solid cash conversion, which is promising. Based on these factors, it's hard to tell if KHD Humboldt Wedag International's profits are a reasonable reflection of its underlying profitability. If you want to do dive deeper into KHD Humboldt Wedag International, you'd also look into what risks it is currently facing. At Simply Wall St, we found 1 warning sign for KHD Humboldt Wedag International and we think they deserve your attention.

Our examination of KHD Humboldt Wedag International 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.

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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.