Why Dafeng Port Heshun Technology's (HKG:8310) Earnings Are Weaker Than They Seem

Investors were disappointed with Dafeng Port Heshun Technology Company Limited's (HKG:8310) recent earnings release. We did some analysis and believe that they might be concerned about some weak underlying factors.

View our latest analysis for Dafeng Port Heshun Technology

A Closer Look At Dafeng Port Heshun Technology'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. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Dafeng Port Heshun Technology has an accrual ratio of 1.07 for the year to December 2023. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of HK$54.7m, a look at free cash flow indicates it actually burnt through HK$18m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of HK$18m, this year, indicates high risk. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part. The good news for shareholders is that Dafeng Port Heshun Technology's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Dafeng Port Heshun Technology.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Dafeng Port Heshun Technology's profit was boosted by unusual items worth HK$107m 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, after all, that's exactly what the accounting terminology implies. We can see that Dafeng Port Heshun Technology's positive unusual items were quite significant relative to its profit in the year to December 2023. 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 Dafeng Port Heshun Technology's Profit Performance

Summing up, Dafeng Port Heshun Technology received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For all the reasons mentioned above, we think that, at a glance, Dafeng Port Heshun Technology's statutory profits could be considered to be low quality, because they are likely to give investors an overly positive impression of the company. If you want to do dive deeper into Dafeng Port Heshun Technology, you'd also look into what risks it is currently facing. For example, we've found that Dafeng Port Heshun Technology has 4 warning signs (3 make us uncomfortable!) that deserve your attention before going any further with your analysis.

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 are plenty of other ways to inform your opinion of a company. 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. 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.