WellCell Holdings' (HKG:2477) Soft Earnings Are Actually Better Than They Appear

Investors weren't pleased with the recent soft earnings report from WellCell Holdings Co., Limited (HKG:2477). Our analysis suggests that while the headline numbers were soft, there are some positive factors which shareholders may have missed.

We've discovered 3 warning signs about WellCell Holdings. View them for free.

Examining Cashflow Against WellCell Holdings' 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. The ratio shows us how much a company's profit exceeds its FCF.

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 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. 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 2024, WellCell Holdings recorded an accrual ratio of 0.54. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of CN¥20.1m, a look at free cash flow indicates it actually burnt through CN¥39m in the last year. We saw that FCF was CN¥5.8m a year ago though, so WellCell Holdings has at least been able to generate positive FCF in the past. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Check out our latest analysis for WellCell Holdings

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

How Do Unusual Items Influence Profit?

Unfortunately (in the short term) WellCell Holdings saw its profit reduced by unusual items worth CN¥185m. If this was a non-cash charge, it would have made the accrual ratio better, if cashflow had stayed strong, so it's not great to see in combination with an uninspiring accrual ratio. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. In the twelve months to December 2024, WellCell Holdings had a big unusual items expense. As a result, we can surmise that the unusual items made its statutory profit significantly weaker than it would otherwise be.

Our Take On WellCell Holdings' Profit Performance

In conclusion, WellCell Holdings' accrual ratio suggests that its statutory earnings are not backed by cash flow, even though unusual items weighed on profit. Based on these factors, it's hard to tell if WellCell Holdings' profits are a reasonable reflection of its underlying profitability. So while earnings quality is important, it's equally important to consider the risks facing WellCell Holdings at this point in time. For example - WellCell Holdings has 3 warning signs we think you should be aware of.

Our examination of WellCell Holdings 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. 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.