Johnson Controls-Hitachi Air Conditioning India's (NSE:JCHAC) Solid Earnings Are Supported By Other Strong Factors

Investors were underwhelmed by the solid earnings posted by Johnson Controls-Hitachi Air Conditioning India Limited (NSE:JCHAC) recently. We did some digging and actually think they are being unnecessarily pessimistic.

See our latest analysis for Johnson Controls-Hitachi Air Conditioning India

A Closer Look At Johnson Controls-Hitachi Air Conditioning India's Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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".

Over the twelve months to September 2024, Johnson Controls-Hitachi Air Conditioning India recorded an accrual ratio of -0.70. That indicates that its free cash flow quite significantly exceeded its statutory profit. Indeed, in the last twelve months it reported free cash flow of ₹4.1b, well over the ₹278.1m it reported in profit. Given that Johnson Controls-Hitachi Air Conditioning India had negative free cash flow in the prior corresponding period, the trailing twelve month resul of ₹4.1b would seem to be a step in the right direction. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

How Do Unusual Items Influence Profit?

Johnson Controls-Hitachi Air Conditioning India's profit was reduced by unusual items worth ₹130m in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. In a scenario where those unusual items included non-cash charges, we'd expect to see a strong accrual ratio, which is exactly what has happened in this case. 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. If Johnson Controls-Hitachi Air Conditioning India doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.

Our Take On Johnson Controls-Hitachi Air Conditioning India's Profit Performance

In conclusion, both Johnson Controls-Hitachi Air Conditioning India's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. Based on these factors, we think Johnson Controls-Hitachi Air Conditioning India's underlying earnings potential is as good as, or probably even better, than the statutory profit makes it seem! So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. While conducting our analysis, we found that Johnson Controls-Hitachi Air Conditioning India has 2 warning signs and it would be unwise to ignore them.

After our examination into the nature of Johnson Controls-Hitachi Air Conditioning India's profit, we've come away optimistic for the company. 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 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.