Jentayu Sustainables Berhad (KLSE:JSB) Is Posting Healthy Earnings, But It Is Not All Good News

Despite posting strong earnings, Jentayu Sustainables Berhad's (KLSE:JSB) stock didn't move much over the last week. We looked deeper into the numbers and found that shareholders might be concerned with some underlying weaknesses.

View our latest analysis for Jentayu Sustainables Berhad

Examining Cashflow Against Jentayu Sustainables Berhad'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). 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.

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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

Jentayu Sustainables Berhad has an accrual ratio of 0.77 for the year to March 2022. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of RM50.2m, a look at free cash flow indicates it actually burnt through RM30m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of RM30m, this year, indicates high risk. However, that's not the end of the story. We can look at how unusual items in the profit and loss statement impacted its accrual ratio, as well as explore how dilution is impacting shareholders negatively. One positive for Jentayu Sustainables Berhad 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 Jentayu Sustainables Berhad.

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, Jentayu Sustainables Berhad issued 59% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. 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 Jentayu Sustainables Berhad's historical EPS growth by clicking on this link.

How Is Dilution Impacting Jentayu Sustainables Berhad's Earnings Per Share? (EPS)

Jentayu Sustainables Berhad was losing money three years ago. Zooming in to the last year, we still can't talk about growth rates coherently, since it made a loss last year. What we do know is that while it's great to see a profit over the last twelve months, that profit would have been better, on a per share basis, if the company hadn't needed to issue shares. Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.

If Jentayu Sustainables Berhad's EPS can grow over time then that drastically improves the chances of the share price moving in the same direction. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For the ordinary retail shareholder, EPS is a great measure to check your hypothetical "share" of the company's profit.

How Do Unusual Items Influence Profit?

The fact that the company had unusual items boosting profit by RM65m, in the last year, probably goes some way to explain why its accrual ratio was so weak. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. Which is hardly surprising, given the name. We can see that Jentayu Sustainables Berhad's positive unusual items were quite significant relative to its profit in the year to March 2022. As a result, we can surmise that the unusual items are making its statutory profit significantly stronger than it would otherwise be.

Our Take On Jentayu Sustainables Berhad's Profit Performance

Jentayu Sustainables Berhad didn't back up its earnings with free cashflow, but this isn't too surprising given profits were inflated by unusual items. Meanwhile, the new shares issued mean that shareholders now own less of the company, unless they tipped in more cash themselves. For all the reasons mentioned above, we think that, at a glance, Jentayu Sustainables Berhad's statutory profits could be considered to be low quality, because they are likely to give investors an overly positive impression of the company. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Case in point: We've spotted 4 warning signs for Jentayu Sustainables Berhad you should be mindful of and 2 of them are concerning.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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. 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.