We're Not Counting On Sang Hing Holdings (International) (HKG:1472) To Sustain Its Statutory Profitability

Broadly speaking, profitable businesses are less risky than unprofitable ones. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether Sang Hing Holdings (International)'s (HKG:1472) statutory profits are a good guide to its underlying earnings.

While Sang Hing Holdings (International) was able to generate revenue of HK$479.8m in the last twelve months, we think its profit result of HK$43.4m was more important. In the chart below, you can see that its profit and revenue have both grown over the last three years, although its profit has slipped in the last twelve months.

View our latest analysis for Sang Hing Holdings (International)

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. Therefore, we think it's worth taking a closer look at Sang Hing Holdings (International)'s cashflow, as well as examining the impact that unusual items have had on its reported profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Sang Hing Holdings (International).

A Closer Look At Sang Hing Holdings (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. The ratio shows us how much a company's profit exceeds its FCF.

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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to September 2020, Sang Hing Holdings (International) recorded an accrual ratio of 0.97. 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 HK$43.4m, a look at free cash flow indicates it actually burnt through HK$89m in the last year. We saw that FCF was HK$12m a year ago though, so Sang Hing Holdings (International) has at least been able to generate positive FCF in the past. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Sang Hing Holdings (International)'s profit was boosted by unusual items worth HK$10m 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'. If Sang Hing Holdings (International) doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On Sang Hing Holdings (International)'s Profit Performance

Summing up, Sang Hing Holdings (International) received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For the reasons mentioned above, we think that a perfunctory glance at Sang Hing Holdings (International)'s statutory profits might make it look better than it really is on an underlying level. If you want to do dive deeper into Sang Hing Holdings (International), you'd also look into what risks it is currently facing. When we did our research, we found 4 warning signs for Sang Hing Holdings (International) (1 is a bit concerning!) that we believe deserve your full attention.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.

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This article by Simply Wall St is general in nature. 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.
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