CSSC Offshore & Marine Engineering (Group)'s (HKG:317) Soft Earnings Don't Show The Whole Picture

CSSC Offshore & Marine Engineering (Group) Company Limited's (HKG:317) stock was strong despite it releasing a soft earnings report last week. Our analysis suggests that investors may have noticed some promising signs beyond the statutory profit figures.

See our latest analysis for CSSC Offshore & Marine Engineering (Group)

Examining Cashflow Against CSSC Offshore & Marine 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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

For the year to December 2023, CSSC Offshore & Marine Engineering (Group) had an accrual ratio of -0.29. Therefore, its statutory earnings were very significantly less than its free cashflow. Indeed, in the last twelve months it reported free cash flow of CN¥2.8b, well over the CN¥48.1m it reported in profit. CSSC Offshore & Marine Engineering (Group) shareholders are no doubt pleased that free cash flow improved over the last twelve months. However, that's not all there is to consider. 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 CSSC Offshore & Marine Engineering (Group).

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that CSSC Offshore & Marine Engineering (Group)'s profit was boosted by unusual items worth CN¥45m 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. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On CSSC Offshore & Marine Engineering (Group)'s Profit Performance

CSSC Offshore & Marine Engineering (Group)'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, we think that CSSC Offshore & Marine Engineering (Group)'s profits are a reasonably conservative guide to its underlying profitability. If you want to do dive deeper into CSSC Offshore & Marine Engineering (Group), you'd also look into what risks it is currently facing. For example, we've discovered 2 warning signs that you should run your eye over to get a better picture of CSSC Offshore & Marine Engineering (Group).

In this article we've looked at a number of factors that can impair the utility of profit numbers, as a guide to a business. But there is always more to discover if you are capable of focussing your mind on minutiae. 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.