Here's Why We Think HANSHIN Engineering & Construction's (KRX:004960) Statutory Earnings Might Be Conservative

It might be old fashioned, but we really like to invest in companies that make a profit, each and every year. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. In this article, we'll look at how useful this year's statutory profit is, when analysing HANSHIN Engineering & Construction (KRX:004960).

It's good to see that over the last twelve months HANSHIN Engineering & Construction made a profit of ₩75.4b on revenue of ₩1.60t. Even though its revenue is down over the last three years, its profit has actually increased, as you can see, below.

See our latest analysis for HANSHIN Engineering & Construction

Not all profits are equal, and we can learn more about the nature of a company's past profitability by diving deeper into the financial statements. Therefore, we think it's worth taking a closer look at HANSHIN Engineering & Construction's cashflow, as well as examining the impact that unusual items have had on its reported profit. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of HANSHIN Engineering & Construction.

A Closer Look At HANSHIN Engineering & Construction's Earnings

One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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.

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

For the year to September 2020, HANSHIN Engineering & Construction had an accrual ratio of -0.27. That implies it has very good cash conversion, and that its earnings in the last year actually significantly understate its free cash flow. In fact, it had free cash flow of ₩256b in the last year, which was a lot more than its statutory profit of ₩75.4b. HANSHIN Engineering & Construction's free cash flow improved over the last year, which is generally good to see. 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.

How Do Unusual Items Influence Profit?

HANSHIN Engineering & Construction's profit was reduced by unusual items worth ₩29b in the last twelve months, and this helped it produce high cash conversion, as reflected by its unusual items. This is what you'd expect to see where a company has a non-cash charge reducing paper profits. 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. Assuming those unusual expenses don't come up again, we'd therefore expect HANSHIN Engineering & Construction to produce a higher profit next year, all else being equal.

Our Take On HANSHIN Engineering & Construction's Profit Performance

In conclusion, both HANSHIN Engineering & Construction's accrual ratio and its unusual items suggest that its statutory earnings are probably reasonably conservative. After considering all this, we reckon HANSHIN Engineering & Construction's statutory profit probably understates its earnings potential! If you want to do dive deeper into HANSHIN Engineering & Construction, you'd also look into what risks it is currently facing. While conducting our analysis, we found that HANSHIN Engineering & Construction has 2 warning signs and it would be unwise to ignore them.

After our examination into the nature of HANSHIN Engineering & Construction'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. Some people consider a high return on equity to be a good sign of a quality business. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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This article by Simply Wall St is general in nature. 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.
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