China Aircraft Leasing Group Holdings's (HKG:1848) Earnings Are Growing But Is There More To The Story?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. That said, the current statutory profit is not always a good guide to a company's underlying profitability. This article will consider whether China Aircraft Leasing Group Holdings' (HKG:1848) statutory profits are a good guide to its underlying earnings.

We like the fact that China Aircraft Leasing Group Holdings made a profit of HK$915.3m on its revenue of HK$1.71b, in the last year. In the chart below, you can see that its profit and revenue have both grown over the last three years.

See our latest analysis for China Aircraft Leasing Group Holdings

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So today we'll look at what China Aircraft Leasing Group Holdings' cashflow tells us about its earnings, as well as examining how issuing shares is impacting shareholder value. 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.

A Closer Look At China Aircraft Leasing Group Holdings' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. 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.

China Aircraft Leasing Group Holdings has an accrual ratio of 0.20 for the year to June 2020. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In the last twelve months it actually had negative free cash flow, with an outflow of HK$6.4b despite its profit of HK$915.3m, mentioned above. We also note that China Aircraft Leasing Group Holdings' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of HK$6.4b. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. China Aircraft Leasing Group Holdings expanded the number of shares on issue by 6.3% over the last year. As a result, its net income is now split between a greater number of shares. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. Check out China Aircraft Leasing Group Holdings' historical EPS growth by clicking on this link.

A Look At The Impact Of China Aircraft Leasing Group Holdings' Dilution on Its Earnings Per Share (EPS).

China Aircraft Leasing Group Holdings has improved its profit over the last three years, with an annualized gain of 41% in that time. And in the last year the company managed to bump profit up by 12%. On the other hand, earnings per share are only up 13% in that time. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, earnings per share growth should beget share price growth. So China Aircraft Leasing Group Holdings shareholders will want to see that EPS figure continue to increase. 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.

Our Take On China Aircraft Leasing Group Holdings' Profit Performance

In conclusion, China Aircraft Leasing Group Holdings has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means its earnings per share growth is weaker than its profit growth. For the reasons mentioned above, we think that a perfunctory glance at China Aircraft Leasing Group Holdings' statutory profits might make it look better than it really is on an underlying level. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. For example, China Aircraft Leasing Group Holdings has 4 warning signs (and 2 which shouldn't be ignored) we think you should know about.

Our examination of China Aircraft Leasing Group Holdings has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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. 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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