Central New Energy Holding Group's (HKG:1735) Performance Raises Some Questions

Even though Central New Energy Holding Group Limited (HKG:1735) posted strong earnings recently, the stock hasn't reacted in a large way. We think that investors might be worried about the foundations the earnings are built on.

See our latest analysis for Central New Energy Holding Group

Examining Cashflow Against Central New Energy Holding Group'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. 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.

Central New Energy Holding Group has an accrual ratio of 0.37 for the year to June 2024. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of HK$638m despite its profit of HK$90.9m, mentioned above. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of HK$638m, this year, indicates high risk. 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Central New Energy Holding Group.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Central New Energy Holding Group's profit was boosted by unusual items worth HK$154m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And that's as you'd expect, given these boosts are described as 'unusual'. Central New Energy Holding Group had a rather significant contribution from unusual items relative to its profit to June 2024. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Central New Energy Holding Group's Profit Performance

Summing up, Central New Energy Holding Group received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Central New Energy Holding Group's profits probably give an overly generous impression of its sustainable level of profitability. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. At Simply Wall St, we found 2 warning signs for Central New Energy Holding Group and we think they deserve your 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.