Zhengye International Holdings' (HKG:3363) Sluggish Earnings Might Be Just The Beginning Of Its Problems

The subdued market reaction suggests that Zhengye International Holdings Company Limited's (HKG:3363) recent earnings didn't contain any surprises. Our analysis suggests that along with soft profit numbers, investors should be aware of some other underlying weaknesses in the numbers.

View our latest analysis for Zhengye International Holdings

A Closer Look At Zhengye International Holdings' 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to December 2020, Zhengye International Holdings recorded an accrual ratio of 0.22. 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¥367m, in contrast to the aforementioned profit of CN¥54.8m. We also note that Zhengye International Holdings' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥367m.

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

Our Take On Zhengye International Holdings' Profit Performance

Zhengye International Holdings didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Because of this, we think that it may be that Zhengye International Holdings' statutory profits are better than its underlying earnings power. Sadly, its EPS was down over the last twelve months. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. So while earnings quality is important, it's equally important to consider the risks facing Zhengye International Holdings at this point in time. To that end, you should learn about the 6 warning signs we've spotted with Zhengye International Holdings (including 3 which are a bit unpleasant).

Today we've zoomed in on a single data point to better understand the nature of Zhengye International Holdings' profit. 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. 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 that insiders are buying to be useful.

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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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