Here's Why We Don't Think HDC Hyundai Development's (KRX:294870) Statutory Earnings Reflect Its Underlying Earnings Potential

Statistically speaking, it is less risky to invest in profitable companies than in unprofitable ones. 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. Today we'll focus on whether this year's statutory profits are a good guide to understanding HDC Hyundai Development (KRX:294870).

While HDC Hyundai Development was able to generate revenue of ₩3.85t in the last twelve months, we think its profit result of ₩383.4b was more important.

View our latest analysis for HDC Hyundai Development

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. So today we'll look at what HDC Hyundai Development's cashflow tells us about its earnings, as well as examining how issuing shares is impacting shareholder value. 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.

Examining Cashflow Against HDC Hyundai Development's Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. This ratio tells us how much of a company's profit is not backed by free cashflow.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. 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 June 2020, HDC Hyundai Development recorded an accrual ratio of 0.41. Statistically speaking, that's a real negative for future earnings. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of ₩383.4b, a look at free cash flow indicates it actually burnt through ₩296b in the last year. It's worth noting that HDC Hyundai Development generated positive FCF of ₩560b a year ago, so at least they've done it in the past. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings. The good news for shareholders is that HDC Hyundai Development'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. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. As it happens, HDC Hyundai Development issued 50% more new shares over the last year. That means its earnings are split among a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out HDC Hyundai Development's historical EPS growth by clicking on this link.

How Is Dilution Impacting HDC Hyundai Development's Earnings Per Share? (EPS)

Unfortunately, we don't have any visibility into its profits three years back, because we lack the data. And even focusing only on the last twelve months, we see profit is down 14%. Sadly, earnings per share fell further, down a full 24% in that time. Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.

In the long term, if HDC Hyundai Development's earnings per share can increase, then the share price should too. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

Our Take On HDC Hyundai Development's Profit Performance

As it turns out, HDC Hyundai Development couldn't match its profit with cashflow and its dilution means that shareholders own less of the company than the did before (unless they bought more shares). On reflection, the above-mentioned factors give us the strong impression that HDC Hyundai Development'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. If you'd like to know more about HDC Hyundai Development as a business, it's important to be aware of any risks it's facing. Every company has risks, and we've spotted 4 warning signs for HDC Hyundai Development (of which 3 are concerning!) you should know about.

Our examination of HDC Hyundai Development 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. 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 that insiders are buying to be useful.

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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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