We're Not Counting On Qianhai Health Holdings (HKG:911) To Sustain Its Statutory Profitability

As a general rule, we think profitable companies are less risky than companies that lose money. Having said that, sometimes statutory profit levels are not a good guide to ongoing profitability, because some short term one-off factor has impacted profit levels. This article will consider whether Qianhai Health Holdings' (HKG:911) statutory profits are a good guide to its underlying earnings.

We like the fact that Qianhai Health Holdings made a profit of HK$25.5m on its revenue of HK$925.0m, in the last year. The good news is that the company managed to grow its revenue over the last three years, and also move from loss-making to profitable.

View our latest analysis for Qianhai Health Holdings

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. Today, we'll discuss Qianhai Health Holdings' free cashflow relative to its earnings, and consider what that tells us about the company. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Qianhai Health Holdings.

A Closer Look At Qianhai Health Holdings' Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. 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 June 2020, Qianhai Health Holdings recorded an accrual ratio of 0.77. 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. In the last twelve months it actually had negative free cash flow, with an outflow of HK$436m despite its profit of HK$25.5m, mentioned above. We also note that Qianhai Health Holdings' free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of HK$436m.

Our Take On Qianhai Health Holdings' Profit Performance

As we have made quite clear, we're a bit worried that Qianhai Health Holdings didn't back up the last year's profit with free cashflow. For this reason, we think that Qianhai Health Holdings' statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The silver lining is that its EPS growth over the last year has been really wonderful, even if it's not a perfect measure. 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. If you want to do dive deeper into Qianhai Health Holdings, you'd also look into what risks it is currently facing. Every company has risks, and we've spotted 3 warning signs for Qianhai Health Holdings (of which 1 is potentially serious!) you should know about.

This note has only looked at a single factor that sheds light on the nature of Qianhai Health Holdings' profit. 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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