We Think That There Are Some Issues For KRN Heat Exchanger and Refrigeration (NSE:KRN) Beyond Its Promising Earnings

KRN Heat Exchanger and Refrigeration Limited (NSE:KRN) just released a solid earnings report, and the stock displayed some strength. Despite this, our analysis suggests that there are some factors weakening the foundations of those good profit numbers.

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Examining Cashflow Against KRN Heat Exchanger and Refrigeration'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. The ratio shows us how much a company's profit exceeds its FCF.

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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

KRN Heat Exchanger and Refrigeration has an accrual ratio of 0.65 for the year to March 2025. As a general rule, that bodes poorly for future profitability. 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 ₹1.3b despite its profit of ₹528.8m, mentioned above. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of ₹1.3b, this year, indicates high risk.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of KRN Heat Exchanger and Refrigeration.

Our Take On KRN Heat Exchanger and Refrigeration's Profit Performance

As we have made quite clear, we're a bit worried that KRN Heat Exchanger and Refrigeration didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that KRN Heat Exchanger and Refrigeration's underlying earnings power is lower than its statutory profit. But the good news is that its EPS growth over the last three years has been very impressive. At the end of the day, it's essential to consider more than just the factors above, if you want to understand the company properly. If you'd like to know more about KRN Heat Exchanger and Refrigeration as a business, it's important to be aware of any risks it's facing. At Simply Wall St, we found 1 warning sign for KRN Heat Exchanger and Refrigeration and we think they deserve your attention.

Today we've zoomed in on a single data point to better understand the nature of KRN Heat Exchanger and Refrigeration's 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. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks with high insider ownership.

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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.