LK Samyang's (KOSDAQ:225190) Profits May Be Overstating Its True Earnings Potential

Shareholders were pleased with the recent earnings report from LK Samyang Co., Ltd (KOSDAQ:225190). Investors should be cautious however, as there some causes of concern deeper in the numbers.

See our latest analysis for LK Samyang

Examining Cashflow Against LK Samyang'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. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. The ratio shows us how much a company's profit exceeds its FCF.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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.

For the year to September 2024, LK Samyang had an accrual ratio of 0.20. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Even though it reported a profit of ₩2.89b, a look at free cash flow indicates it actually burnt through ₩3.3b in the last year. It's worth noting that LK Samyang generated positive FCF of ₩2.2b a year ago, so at least they've done it in the past. However, as we will discuss below, we can see that the company's accrual ratio has been impacted by its tax situation. This would certainly have contributed to the weak cash conversion. One positive for LK Samyang shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.

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

An Unusual Tax Situation

Moving on from the accrual ratio, we note that LK Samyang profited from a tax benefit which contributed ₩2.2b to profit. This is of course a bit out of the ordinary, given it is more common for companies to be paying tax than receiving tax benefits! We're sure the company was pleased with its tax benefit. However, the devil in the detail is that these kind of benefits only impact in the year they are booked, and are often one-off in nature. In the likely event the tax benefit is not repeated, we'd expect to see its statutory profit levels drop, at least in the absence of strong growth.

Our Take On LK Samyang's Profit Performance

This year, LK Samyang couldn't match its profit with cashflow. If the tax benefit is not repeated, then profit would drop next year, all else being equal. For the reasons mentioned above, we think that a perfunctory glance at LK Samyang's statutory profits might make it look better than it really is on an underlying level. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. For example - LK Samyang has 4 warning signs we think you should be aware of.

Our examination of LK Samyang 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. 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.