We're Not So Sure You Should Rely on Qinqin Foodstuffs Group (Cayman)'s (HKG:1583) Statutory Earnings

Broadly speaking, profitable businesses are less risky than unprofitable ones. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. This article will consider whether Qinqin Foodstuffs Group (Cayman)'s (HKG:1583) statutory profits are a good guide to its underlying earnings.

While Qinqin Foodstuffs Group (Cayman) was able to generate revenue of CN¥759.1m in the last twelve months, we think its profit result of CN¥99.4m was more important.

Check out our latest analysis for Qinqin Foodstuffs Group (Cayman)

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. Therefore, today we'll take a look at Qinqin Foodstuffs Group (Cayman)'s cashflow, share issues and unusual items with a view to better understanding the nature of its statutory earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Qinqin Foodstuffs Group (Cayman).

Examining Cashflow Against Qinqin Foodstuffs Group (Cayman)'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Over the twelve months to June 2020, Qinqin Foodstuffs Group (Cayman) recorded an accrual ratio of 0.46. 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¥99.4m, a look at free cash flow indicates it actually burnt through CN¥72m in the last year. We saw that FCF was CN¥31m a year ago though, so Qinqin Foodstuffs Group (Cayman) has at least been able to generate positive FCF in the past. 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.

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. Qinqin Foodstuffs Group (Cayman) expanded the number of shares on issue by 12% over the last year. Therefore, each share now receives a smaller portion of profit. 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 Qinqin Foodstuffs Group (Cayman)'s EPS by clicking here.

A Look At The Impact Of Qinqin Foodstuffs Group (Cayman)'s Dilution on Its Earnings Per Share (EPS).

We don't have any data on the company's profits from three years ago. The good news is that profit was up 142% in the last twelve months. On the other hand, earnings per share are only up 114% over the same period. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, earnings per share growth should beget share price growth. So Qinqin Foodstuffs Group (Cayman) shareholders will want to see that EPS figure continue to increase. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by CN¥16m, 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 that's as you'd expect, given these boosts are described as 'unusual'. 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 Qinqin Foodstuffs Group (Cayman)'s Profit Performance

In conclusion, Qinqin Foodstuffs Group (Cayman)'s 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. On reflection, the above-mentioned factors give us the strong impression that Qinqin Foodstuffs Group (Cayman)'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For instance, we've identified 2 warning signs for Qinqin Foodstuffs Group (Cayman) (1 shouldn't be ignored) you should be familiar with.

Our examination of Qinqin Foodstuffs Group (Cayman) has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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. 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. 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.
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