We Think That There Are Issues Underlying Pharmaniaga Berhad's (KLSE:PHARMA) Earnings

Pharmaniaga Berhad's (KLSE:PHARMA) robust earnings report didn't manage to move the market for its stock. We did some digging, and we found some concerning factors in the details.

See our latest analysis for Pharmaniaga Berhad

Examining Cashflow Against Pharmaniaga 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. 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. 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 2021, Pharmaniaga Berhad recorded an accrual ratio of 0.35. Unfortunately, that means its free cash flow was a lot less than its statutory profit, which makes us doubt the utility of profit as a guide. In the last twelve months it actually had negative free cash flow, with an outflow of RM394m despite its profit of RM32.0m, mentioned above. We saw that FCF was RM48m a year ago though, so Pharmaniaga Berhad has at least been able to generate positive FCF in the past. The good news for shareholders is that Pharmaniaga Berhad's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. As a result, some shareholders may be looking for stronger cash conversion in the current year.

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.

Our Take On Pharmaniaga Berhad's Profit Performance

As we have made quite clear, we're a bit worried that Pharmaniaga Berhad didn't back up the last year's profit with free cashflow. As a result, we think it may well be the case that Pharmaniaga Berhad's underlying earnings power is lower than its statutory profit. The good news is that it earned a profit in the last twelve months, despite its previous loss. 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. With this in mind, we wouldn't consider investing in a stock unless we had a thorough understanding of the risks. Be aware that Pharmaniaga Berhad is showing 3 warning signs in our investment analysis and 2 of those are potentially serious...

Today we've zoomed in on a single data point to better understand the nature of Pharmaniaga 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. 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.
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