We Think That There Are More Issues For Nissei Plastic IndustrialLtd (TSE:6293) Than Just Sluggish Earnings

Investors were disappointed by Nissei Plastic Industrial Co.,Ltd.'s (TSE:6293 ) latest earnings release. We did some analysis, and found that there are some reasons to be cautious about the headline numbers.

See our latest analysis for Nissei Plastic IndustrialLtd

Examining Cashflow Against Nissei Plastic IndustrialLtd'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'.

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 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Nissei Plastic IndustrialLtd has an accrual ratio of 0.26 for the year to March 2024. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of JP¥376.0m, a look at free cash flow indicates it actually burnt through JP¥13b in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of JP¥13b, this year, indicates high risk. Having said that, there is more to the story. 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 Nissei Plastic IndustrialLtd.

How Do Unusual Items Influence Profit?

Given the accrual ratio, it's not overly surprising that Nissei Plastic IndustrialLtd's profit was boosted by unusual items worth JP¥254m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And that's as you'd expect, given these boosts are described as 'unusual'. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Nissei Plastic IndustrialLtd's Profit Performance

Summing up, Nissei Plastic IndustrialLtd received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. Considering all this we'd argue Nissei Plastic IndustrialLtd's profits probably give an overly generous impression of its sustainable level of profitability. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Our analysis shows 5 warning signs for Nissei Plastic IndustrialLtd (3 are concerning!) and we strongly recommend you look at these before investing.

Our examination of Nissei Plastic IndustrialLtd has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. But there are plenty of other ways to inform your opinion of a company. 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.