New Horizon Health (HKG:6606) Is Posting Healthy Earnings, But It Is Not All Good News

We didn't see New Horizon Health Limited's (HKG:6606) stock surge when it reported robust earnings recently. We looked deeper into the numbers and found that shareholders might be concerned with some underlying weaknesses.

Check out our latest analysis for New Horizon Health

A Closer Look At New Horizon Health's 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. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. 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 2023, New Horizon Health recorded an accrual ratio of 0.63. 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. Over the last year it actually had negative free cash flow of CN¥630m, in contrast to the aforementioned profit of CN¥111.7m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥630m, 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.

Our data indicates that New Horizon Health insiders have been buying shares! If you are like me, that'll make you wonder who exactly bought... and what price they paid! Soclick here to find out (using our intuitive visualisation of insider trading).

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by CN¥15m, 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. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. Which is hardly surprising, given the name. If New Horizon Health doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On New Horizon Health's Profit Performance

Summing up, New Horizon Health received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue New Horizon Health's profits probably give an overly generous impression of its sustainable level of profitability. If you want to do dive deeper into New Horizon Health, you'd also look into what risks it is currently facing. For example, we've found that New Horizon Health has 3 warning signs (1 shouldn't be ignored!) that deserve your attention before going any further with your analysis.

Our examination of New Horizon Health 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. 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.