Heng Huat Resources Group Berhad's (KLSE:HHGROUP) Robust Earnings Are Supported By Other Strong Factors

Heng Huat Resources Group Berhad's (KLSE:HHGROUP) robust earnings report didn't manage to move the market for its stock. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.

See our latest analysis for Heng Huat Resources Group Berhad

Zooming In On Heng Huat Resources Group 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. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. The ratio shows us how much a company's profit exceeds its FCF.

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

Heng Huat Resources Group Berhad has an accrual ratio of -0.72 for the year to December 2021. Therefore, its statutory earnings were very significantly less than its free cashflow. To wit, it produced free cash flow of RM37m during the period, dwarfing its reported profit of RM4.82m. Heng Huat Resources Group Berhad's free cash flow improved over the last year, which is generally good to see. Unfortunately for shareholders, the company has also been issuing new shares, diluting their share of future earnings.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Heng Huat Resources Group Berhad.

One essential aspect of assessing earnings quality is to look at how much a company is diluting shareholders. In fact, Heng Huat Resources Group Berhad increased the number of shares on issue by 52% over the last twelve months by issuing new shares. Therefore, each share now receives a smaller portion of profit. Per share metrics like EPS help us understand how much actual shareholders are benefitting from the company's profits, while the net income level gives us a better view of the company's absolute size. You can see a chart of Heng Huat Resources Group Berhad's EPS by clicking here.

How Is Dilution Impacting Heng Huat Resources Group Berhad's Earnings Per Share? (EPS)

Three years ago, Heng Huat Resources Group Berhad lost money. Zooming in to the last year, we still can't talk about growth rates coherently, since it made a loss last year. But mathematics aside, it is always good to see when a formerly unprofitable business come good (though we accept profit would have been higher if dilution had not been required). Therefore, one can observe that the dilution is having a fairly profound effect on shareholder returns.

In the long term, if Heng Huat Resources Group Berhad's earnings per share can increase, then the share price should too. 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.

Our Take On Heng Huat Resources Group Berhad's Profit Performance

In conclusion, Heng Huat Resources Group Berhad has a strong cashflow relative to earnings, which indicates good quality earnings, but the dilution means its earnings per share are dropping faster than its profit. Given the contrasting considerations, we don't have a strong view as to whether Heng Huat Resources Group Berhad's profits are an apt reflection of its underlying potential for profit. So while earnings quality is important, it's equally important to consider the risks facing Heng Huat Resources Group Berhad at this point in time. To that end, you should learn about the 2 warning signs we've spotted with Heng Huat Resources Group Berhad (including 1 which doesn't sit too well with us).

Our examination of Heng Huat Resources Group 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. 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. 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.