There May Be Reason For Hope In Nippon Pallet Pool's (TSE:4690) Disappointing Earnings

Investors were disappointed with the weak earnings posted by Nippon Pallet Pool Co., Ltd. (TSE:4690 ). Despite the soft profit numbers, our analysis has optimistic about the overall quality of the income statement.

View our latest analysis for Nippon Pallet Pool

A Closer Look At Nippon Pallet Pool'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to September 2024, Nippon Pallet Pool had an accrual ratio of -0.19. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. Indeed, in the last twelve months it reported free cash flow of JP¥1.8b, well over the JP¥292.0m it reported in profit. Notably, Nippon Pallet Pool had negative free cash flow last year, so the JP¥1.8b it produced this year was a welcome improvement. 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.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Nippon Pallet Pool.

How Do Unusual Items Influence Profit?

Nippon Pallet Pool's profit was reduced by unusual items worth JP¥196m 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. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And that's hardly a surprise given these line items are considered unusual. If Nippon Pallet Pool 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 Nippon Pallet Pool's Profit Performance

Considering both Nippon Pallet Pool's accrual ratio and its unusual items, we think its statutory earnings are unlikely to exaggerate the company's underlying earnings power. After considering all this, we reckon Nippon Pallet Pool's statutory profit probably understates its earnings potential! So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. In terms of investment risks, we've identified 3 warning signs with Nippon Pallet Pool, and understanding these should be part of your investment process.

After our examination into the nature of Nippon Pallet Pool'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. 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.