Concerns Surrounding SINOPEC Engineering (Group)'s (HKG:2386) Performance

SINOPEC Engineering (Group) Co., Ltd.'s (HKG:2386) robust recent earnings didn't do much to move the stock. However the statutory profit number doesn't tell the whole story, and we have found some factors which might be of concern to shareholders.

Check out our latest analysis for SINOPEC Engineering (Group)

A Closer Look At SINOPEC Engineering (Group)'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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to June 2024, SINOPEC Engineering (Group) recorded an accrual ratio of 0.38. 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 CN¥2.34b, a look at free cash flow indicates it actually burnt through CN¥1.1b in the last year. We saw that FCF was CN¥6.7b a year ago though, so SINOPEC Engineering (Group) has at least been able to generate positive FCF in the past. One positive for SINOPEC Engineering (Group) shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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.

Our Take On SINOPEC Engineering (Group)'s Profit Performance

As we have made quite clear, we're a bit worried that SINOPEC Engineering (Group) didn't back up the last year's profit with free cashflow. For this reason, we think that SINOPEC Engineering (Group)'s statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The good news is that its earnings per share increased slightly in the last year. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Our analysis shows 2 warning signs for SINOPEC Engineering (Group) (1 doesn't sit too well with us!) and we strongly recommend you look at them before investing.

Today we've zoomed in on a single data point to better understand the nature of SINOPEC Engineering (Group)'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 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.