Sanai Health Industry Group's (HKG:1889) Sluggish Earnings Might Be Just The Beginning Of Its Problems

The latest earnings report from Sanai Health Industry Group Company Limited (HKG:1889 ) disappointed investors. We did some digging and believe that things are better than they seem due to some encouraging factors.

View our latest analysis for Sanai Health Industry Group

Examining Cashflow Against Sanai Health Industry Group'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. 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. 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. 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. 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, Sanai Health Industry Group had an accrual ratio of -1.41. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. To wit, it produced free cash flow of CN¥162m during the period, dwarfing its reported profit of CN¥13.1m. Sanai Health Industry Group's free cash flow improved over the last year, which is generally good to see. 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Sanai Health Industry Group.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. As it happens, Sanai Health Industry Group issued 19% more new shares 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 Sanai Health Industry Group's EPS by clicking here.

A Look At The Impact Of Sanai Health Industry Group's Dilution On Its Earnings Per Share (EPS)

Sanai Health Industry Group has improved its profit over the last three years, with an annualized gain of 27% in that time. Net income was down 64% over the last twelve months. Unfortunately for shareholders, though, the earnings per share result was even worse, declining 66%. Therefore, the dilution is having a noteworthy influence on shareholder returns.

In the long term, if Sanai Health Industry Group's earnings per share can increase, then the share price should too. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

How Do Unusual Items Influence Profit?

While the accrual ratio might bode well, we also note that Sanai Health Industry Group's profit was boosted by unusual items worth CN¥19m 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. We can see that Sanai Health Industry Group's positive unusual items were quite significant relative to its profit in the year to June 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 Sanai Health Industry Group's Profit Performance

In conclusion, Sanai Health Industry Group's accrual ratio suggests its earnings are well backed by cash but its boost from unusual items is probably not going to be repeated consistently. Further, the dilution means profits are now split more ways. After taking into account all the aforementioned observations we think that Sanai Health Industry Group's profits probably give a generous impression of its sustainable level of profitability. If you'd like to know more about Sanai Health Industry Group as a business, it's important to be aware of any risks it's facing. Be aware that Sanai Health Industry Group is showing 6 warning signs in our investment analysis and 2 of those make us uncomfortable...

Our examination of Sanai Health Industry Group 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. 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.