Why Starjoy Wellness and Travel's (HKG:3662) Shaky Earnings Are Just The Beginning Of Its Problems

The latest earnings report from Starjoy Wellness and Travel Company Limited (HKG:3662 ) 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 Starjoy Wellness and Travel

Examining Cashflow Against Starjoy Wellness and Travel'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). 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'.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. 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 December 2023, Starjoy Wellness and Travel recorded an accrual ratio of 0.23. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Indeed, in the last twelve months it reported free cash flow of CN¥94m, which is significantly less than its profit of CN¥157.1m. Notably, Starjoy Wellness and Travel had negative free cash flow last year, so the CN¥94m it produced this year was a welcome improvement. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Starjoy Wellness and Travel.

How Do Unusual Items Influence Profit?

Unfortunately (in the short term) Starjoy Wellness and Travel saw its profit reduced by unusual items worth CN¥24m. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. While deductions due to unusual items are disappointing in the first instance, there is a silver lining. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. Assuming those unusual expenses don't come up again, we'd therefore expect Starjoy Wellness and Travel to produce a higher profit next year, all else being equal.

Our Take On Starjoy Wellness and Travel's Profit Performance

In conclusion, Starjoy Wellness and Travel's accrual ratio suggests that its statutory earnings are not backed by cash flow, even though unusual items weighed on profit. Given the contrasting considerations, we don't have a strong view as to whether Starjoy Wellness and Travel's profits are an apt reflection of its underlying potential for profit. If you'd like to know more about Starjoy Wellness and Travel as a business, it's important to be aware of any risks it's facing. When we did our research, we found 3 warning signs for Starjoy Wellness and Travel (2 make us uncomfortable!) that we believe deserve your full attention.

Our examination of Starjoy Wellness and Travel has focussed on certain factors that can make its earnings look better than they are. 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 that insiders are buying 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.