Kinki Sharyo's (TSE:7122) Problems Go Beyond Poor Profit

The Kinki Sharyo Co., Ltd. (TSE:7122) recently posted soft earnings but shareholders didn't react strongly. We did some analysis and found some concerning details beneath the statutory profit number.

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A Closer Look At Kinki Sharyo's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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 having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to March 2025, Kinki Sharyo recorded an accrual ratio of 0.23. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Over the last year it actually had negative free cash flow of JP¥5.9b, in contrast to the aforementioned profit of JP¥560.0m. It's worth noting that Kinki Sharyo generated positive FCF of JP¥8.3b a year ago, so at least they've done it in the past. 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. The good news for shareholders is that Kinki Sharyo's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

Check out our latest analysis for Kinki Sharyo

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

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Kinki Sharyo's profit was boosted by unusual items worth JP¥321m 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. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And, after all, that's exactly what the accounting terminology implies. Kinki Sharyo had a rather significant contribution from unusual items relative to its profit to March 2025. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Kinki Sharyo's Profit Performance

Kinki Sharyo had a weak accrual ratio, but its profit did receive a boost from unusual items. For the reasons mentioned above, we think that a perfunctory glance at Kinki Sharyo's statutory profits might make it look better than it really is on an underlying level. So while earnings quality is important, it's equally important to consider the risks facing Kinki Sharyo at this point in time. For example, Kinki Sharyo has 4 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

Our examination of Kinki Sharyo 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 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 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.