We Think You Should Be Aware Of Some Concerning Factors In Wanda Hotel Development's (HKG:169) Earnings

Wanda Hotel Development Company Limited (HKG:169) just released a solid earnings report, and the stock displayed some strength. However, we think that shareholders should be cautious as we found some worrying factors underlying the profit.

View our latest analysis for Wanda Hotel Development

Zooming In On Wanda Hotel Development'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. 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. 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 2020, Wanda Hotel Development recorded an accrual ratio of 0.39. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of HK$1.1b, in contrast to the aforementioned profit of HK$31.1m. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of HK$1.1b, this year, indicates high risk. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Wanda Hotel Development.

The Impact Of Unusual Items On Profit

Unfortunately (in the short term) Wanda Hotel Development saw its profit reduced by unusual items worth HK$35m. 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. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. 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 Wanda Hotel Development to produce a higher profit next year, all else being equal.

Our Take On Wanda Hotel Development's Profit Performance

Wanda Hotel Development saw unusual items weigh on its profit, which should have made it easier to show high cash conversion, which it did not do, according to its accrual ratio. Having considered these factors, we don't think Wanda Hotel Development's statutory profits give an overly harsh view of the business. If you'd like to know more about Wanda Hotel Development as a business, it's important to be aware of any risks it's facing. For example, we've found that Wanda Hotel Development has 2 warning signs (1 doesn't sit too well with us!) that deserve your attention before going any further with your analysis.

Our examination of Wanda Hotel Development has focussed on certain factors that can make its earnings look better than they are. But there is always more to discover if you are capable of focussing your mind on minutiae. 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. 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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