Shenghui Cleanness Group Holdings' (HKG:2521) Earnings Aren't As Good As They Appear

Investors were disappointed with Shenghui Cleanness Group Holdings Limited's (HKG:2521) recent earnings release. We did some analysis and believe that they might be concerned about some weak underlying factors.

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Zooming In On Shenghui Cleanness Group Holdings' 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). 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'.

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. 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".

For the year to June 2025, Shenghui Cleanness Group Holdings had an accrual ratio of 0.21. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of CN¥15m, in contrast to the aforementioned profit of CN¥47.0m. We also note that Shenghui Cleanness Group Holdings' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥15m. However, that's not the end of the story. We can look at how unusual items in the profit and loss statement impacted its accrual ratio, as well as explore how dilution is impacting shareholders negatively.

See our latest analysis for Shenghui Cleanness Group Holdings

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shenghui Cleanness Group Holdings.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. As it happens, Shenghui Cleanness Group Holdings issued 20% more new shares over the last year. That means its earnings are split among 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. You can see a chart of Shenghui Cleanness Group Holdings' EPS by clicking here.

How Is Dilution Impacting Shenghui Cleanness Group Holdings' Earnings Per Share (EPS)?

As you can see above, Shenghui Cleanness Group Holdings has been growing its net income over the last few years, with an annualized gain of 26% over three years. But EPS was only up per year, in the exact same period. And at a glance the 107% gain in profit over the last year impresses. But in comparison, EPS only increased by 78% over the same period. So you can see that the dilution has had a bit of an impact on shareholders.

In the long term, earnings per share growth should beget share price growth. So Shenghui Cleanness 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.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by CN¥37m, in the last year, probably goes some way to explain why its accrual ratio was so weak. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. 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 Shenghui Cleanness Group Holdings' positive unusual items were quite significant relative to its profit in the year to June 2025. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Shenghui Cleanness Group Holdings' Profit Performance

In conclusion, Shenghui Cleanness Group Holdings' weak accrual ratio suggested its statutory earnings have been inflated by the unusual items. Meanwhile, the new shares issued mean that shareholders now own less of the company, unless they tipped in more cash themselves. For all the reasons mentioned above, we think that, at a glance, Shenghui Cleanness Group Holdings' 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 Shenghui Cleanness Group Holdings, you'd also look into what risks it is currently facing. Case in point: We've spotted 3 warning signs for Shenghui Cleanness Group Holdings you should be mindful of and 1 of them is a bit unpleasant.

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. 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 with significant insider holdings 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.