MN Holdings Berhad's (KLSE:MNHLDG) Soft Earnings Don't Show The Whole Picture

Soft earnings didn't appear to concern MN Holdings Berhad's (KLSE:MNHLDG) shareholders over the last week. We did some digging, and we believe the earnings are stronger than they seem.

View our latest analysis for MN Holdings Berhad

Examining Cashflow Against MN Holdings Berhad'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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

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

Over the twelve months to June 2022, MN Holdings Berhad recorded an accrual ratio of 0.22. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Over the last year it actually had negative free cash flow of RM3.5m, in contrast to the aforementioned profit of RM5.58m. We saw that FCF was RM4.5m a year ago though, so MN Holdings Berhad has at least been able to generate positive FCF in the past. Having said that, there is more to the story. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

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.

How Do Unusual Items Influence Profit?

MN Holdings Berhad's profit suffered from unusual items, which reduced profit by RM2.0m in the last twelve months. If this was a non-cash charge, it would have made the accrual ratio better, if cashflow had stayed strong, so it's not great to see in combination with an uninspiring accrual ratio. 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, after all, that's exactly what the accounting terminology implies. Assuming those unusual expenses don't come up again, we'd therefore expect MN Holdings Berhad to produce a higher profit next year, all else being equal.

Our Take On MN Holdings Berhad's Profit Performance

MN Holdings Berhad saw unusual items weigh on its profit, which should have made it easier to show high cash conversion, which it did not do, according to its accrual ratio. Given the contrasting considerations, we don't have a strong view as to whether MN Holdings Berhad's profits are an apt reflection of its underlying potential for profit. If you'd like to know more about MN Holdings Berhad as a business, it's important to be aware of any risks it's facing. When we did our research, we found 3 warning signs for MN Holdings Berhad (1 is a bit unpleasant!) that we believe deserve your full attention.

Our examination of MN Holdings Berhad has focussed on certain factors that can make its earnings look better than they are. But there are plenty of other ways to inform your opinion of a company. 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.