We Think That There Are Some Issues For PDZ Holdings Bhd (KLSE:PDZ) Beyond Its Promising Earnings

The stock price didn't jump after PDZ Holdings Bhd (KLSE:PDZ) posted decent earnings last week. We think that investors might be worried about some concerning underlying factors.

See our latest analysis for PDZ Holdings Bhd

Examining Cashflow Against PDZ Holdings Bhd'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. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to June 2024, PDZ Holdings Bhd had an accrual ratio of 3.70. 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. In the last twelve months it actually had negative free cash flow, with an outflow of RM25m despite its profit of RM5.21m, mentioned above. We also note that PDZ Holdings Bhd's free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of RM25m. However, that's not all there is to consider. The accrual ratio is reflecting the impact of unusual items on statutory profit, at least in part.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of PDZ Holdings Bhd.

How Do Unusual Items Influence Profit?

Unfortunately (in the short term) PDZ Holdings Bhd saw its profit reduced by unusual items worth RM3.0m. 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. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And, after all, that's exactly what the accounting terminology implies. PDZ Holdings Bhd took a rather significant hit from unusual items in the year to June 2024. All else being equal, this would likely have the effect of making the statutory profit look worse than its underlying earnings power.

Our Take On PDZ Holdings Bhd's Profit Performance

PDZ Holdings Bhd 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. Having considered these factors, we don't think PDZ Holdings Bhd's statutory profits give an overly harsh view of the business. If you want to do dive deeper into PDZ Holdings Bhd, you'd also look into what risks it is currently facing. Be aware that PDZ Holdings Bhd is showing 4 warning signs in our investment analysis and 3 of those don't sit too well with us...

Our examination of PDZ Holdings Bhd 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 with significant insider holdings 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.