Shaky Earnings May Not Tell The Whole Story For Cnergenz Berhad (KLSE:CNERGEN)

Cnergenz Berhad (KLSE:CNERGEN) recently posted soft earnings but shareholders didn't react strongly. We did some analysis and found some concerning details beneath the statutory profit number.

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Examining Cashflow Against Cnergenz 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. This ratio tells us how much of a company's profit is not backed by free cashflow.

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

For the year to December 2024, Cnergenz Berhad had an accrual ratio of 0.35. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. In the last twelve months it actually had negative free cash flow, with an outflow of RM4.6m despite its profit of RM11.4m, mentioned above. We saw that FCF was RM17m a year ago though, so Cnergenz 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. One positive for Cnergenz 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.

See our latest analysis for Cnergenz Berhad

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

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Cnergenz Berhad's profit was boosted by unusual items worth RM1.6m in the last twelve months. While we like to see profit increases, we tend to be a little more cautious when unusual items have made a big contribution. We ran the numbers on most publicly listed companies worldwide, and it's very common for unusual items to be once-off in nature. And, after all, that's exactly what the accounting terminology implies. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Cnergenz Berhad's Profit Performance

Cnergenz Berhad had a weak accrual ratio, but its profit did receive a boost from unusual items. Considering all this we'd argue Cnergenz Berhad's profits probably give an overly generous impression of its sustainable level of profitability. So while earnings quality is important, it's equally important to consider the risks facing Cnergenz Berhad at this point in time. To that end, you should learn about the 5 warning signs we've spotted with Cnergenz Berhad (including 2 which shouldn't be ignored).

Our examination of Cnergenz Berhad has focussed on certain factors that can make its earnings look better than they are. And, on that basis, we are somewhat skeptical. 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 with high insider ownership.

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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.