We Think That There Are More Issues For Qilu Expressway (HKG:1576) Than Just Sluggish Earnings

Qilu Expressway Company Limited's (HKG:1576) recent weak earnings report didn't cause a big stock movement. We think that investors are worried about some weaknesses underlying the earnings.

View our latest analysis for Qilu Expressway

Zooming In On Qilu Expressway's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. 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 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".

Qilu Expressway has an accrual ratio of 0.40 for the year to December 2023. 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. In the last twelve months it actually had negative free cash flow, with an outflow of CN¥3.5b despite its profit of CN¥525.3m, mentioned above. We also note that Qilu Expressway's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of CN¥3.5b.

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

Our Take On Qilu Expressway's Profit Performance

As we have made quite clear, we're a bit worried that Qilu Expressway didn't back up the last year's profit with free cashflow. For this reason, we think that Qilu Expressway's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. Sadly, its EPS was down over the last twelve months. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. When we did our research, we found 4 warning signs for Qilu Expressway (2 are potentially serious!) that we believe deserve your full attention.

Today we've zoomed in on a single data point to better understand the nature of Qilu Expressway's profit. But there is always more to discover if you are capable of focussing your mind on minutiae. 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 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.