We Think Hong Leong Industries Berhad's (KLSE:HLIND) Statutory Profit Might Understate Its Earnings Potential

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 Hong Leong Industries Berhad (KLSE:HLIND).

We like the fact that Hong Leong Industries Berhad made a profit of RM167.4m on its revenue of RM2.22b, in the last year. As depicted below, while its revenue may have fallen over the last few years, its profit actually improved.

View our latest analysis for Hong Leong Industries Berhad

Of course, when it comes to statutory profit, the devil is often in the detail, and we can get a better sense for a company by diving deeper into the financial statements. So today we'll look at what Hong Leong Industries Berhad's cashflow tells us about the quality of its earnings. Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hong Leong Industries Berhad.

A Closer Look At Hong Leong Industries Berhad'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. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Hong Leong Industries Berhad has an accrual ratio of -0.30 for the year to September 2020. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of RM362m during the period, dwarfing its reported profit of RM167.4m. Hong Leong Industries Berhad's free cash flow actually declined over the last year, which is disappointing, like non-biodegradable balloons.

Our Take On Hong Leong Industries Berhad's Profit Performance

As we discussed above, Hong Leong Industries Berhad's accrual ratio indicates strong conversion of profit to free cash flow, which is a positive for the company. Based on this observation, we consider it possible that Hong Leong Industries Berhad's statutory profit actually understates its earnings potential! And the EPS is up 37% annually, over the last three years. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. So if you'd like to dive deeper into this stock, it's crucial to consider any risks it's facing. Case in point: We've spotted 2 warning signs for Hong Leong Industries Berhad you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of Hong Leong Industries Berhad's profit. 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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