Huili Resources (Group)'s (HKG:1303) Problems Go Beyond Poor Profit

Investors were disappointed with Huili Resources (Group) Limited's (HKG:1303) recent earnings. We think that they may have more to worry about than just soft profit numbers.

View our latest analysis for Huili Resources (Group)

Examining Cashflow Against Huili Resources (Group)'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). 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. 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 2024, Huili Resources (Group) had an accrual ratio of 0.81. 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¥214m, in contrast to the aforementioned profit of CN¥202.3m. It's worth noting that Huili Resources (Group) generated positive FCF of CN¥269m a year ago, so at least they've done it in the past. However, that's not the end of the story. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares. One positive for Huili Resources (Group) 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. 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 Huili Resources (Group).

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. Huili Resources (Group) expanded the number of shares on issue by 13% over the last year. That means its earnings are split among a greater number of shares. To talk about net income, without noticing earnings per share, is to be distracted by the big numbers while ignoring the smaller numbers that talk to per share value. You can see a chart of Huili Resources (Group)'s EPS by clicking here.

How Is Dilution Impacting Huili Resources (Group)'s Earnings Per Share (EPS)?

Three years ago, Huili Resources (Group) lost money. And even focusing only on the last twelve months, we see profit is down 16%. Like a sack of potatoes thrown from a delivery truck, EPS fell harder, down 26% in the same period. And so, you can see quite clearly that dilution is influencing shareholder earnings.

In the long term, if Huili Resources (Group)'s earnings per share can increase, then the share price should too. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. 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

Given the accrual ratio, it's not overly surprising that Huili Resources (Group)'s profit was boosted by unusual items worth CN¥20m in the last twelve months. 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. And that's as you'd expect, given these boosts are described as 'unusual'. If Huili Resources (Group) 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 Huili Resources (Group)'s Profit Performance

Huili Resources (Group) didn't back up its earnings with free cashflow, but this isn't too surprising given profits were inflated by 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 Huili Resources (Group)'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. If you want to do dive deeper into Huili Resources (Group), you'd also look into what risks it is currently facing. To that end, you should learn about the 3 warning signs we've spotted with Huili Resources (Group) (including 1 which shouldn't be ignored).

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 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.