Nan Nan Resources Enterprise's (HKG:1229) Earnings Might Be Weaker Than You Think

Solid profit numbers didn't seem to be enough to please Nan Nan Resources Enterprise Limited's (HKG:1229) shareholders. We think that they might be concerned about some underlying details that our analysis found.

View our latest analysis for Nan Nan Resources Enterprise

A Closer Look At Nan Nan Resources Enterprise's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Nan Nan Resources Enterprise has an accrual ratio of 0.38 for the year to March 2024. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of HK$33m, in contrast to the aforementioned profit of HK$39.1m. We saw that FCF was HK$22m a year ago though, so Nan Nan Resources Enterprise has at least been able to generate positive FCF in the past. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part. One positive for Nan Nan Resources Enterprise 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Nan Nan Resources Enterprise.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Nan Nan Resources Enterprise's profit was boosted by unusual items worth HK$62m in the last twelve months. While it's always nice to have higher profit, a large contribution from unusual items sometimes dampens our enthusiasm. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And, after all, that's exactly what the accounting terminology implies. Nan Nan Resources Enterprise had a rather significant contribution from unusual items relative to its profit to March 2024. 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 Nan Nan Resources Enterprise's Profit Performance

Nan Nan Resources Enterprise had a weak accrual ratio, but its profit did receive a boost from unusual items. For the reasons mentioned above, we think that a perfunctory glance at Nan Nan Resources Enterprise's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Nan Nan Resources Enterprise as a business, it's important to be aware of any risks it's facing. Be aware that Nan Nan Resources Enterprise is showing 3 warning signs in our investment analysis and 1 of those makes us a bit uncomfortable...

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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com