Why Pacific Radiance's (SGX:RXS) Healthy Earnings Aren’t As Good As They Seem

Investors appear disappointed with Pacific Radiance Ltd.'s (SGX:RXS) recent earnings, despite the decent statutory profit number. Our analysis has found some underlying factors which may be cause for concern.

Our analysis indicates that RXS is potentially undervalued!

Zooming In On Pacific Radiance's Earnings

In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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'.

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".

For the year to September 2022, Pacific Radiance had an accrual ratio of 4.22. Ergo, its free cash flow is significantly weaker than its profit. Statistically speaking, that's a real negative for future earnings. In fact, it had free cash flow of US$4.3m in the last year, which was a lot less than its statutory profit of US$330.3m. Pacific Radiance's free cash flow actually declined over the last year, but it may bounce back next year, since free cash flow is often more volatile than accounting profits. Notably, the company has issued new shares, thus diluting existing shareholders and reducing their share of future earnings. One positive for Pacific Radiance 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.

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

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. Pacific Radiance expanded the number of shares on issue by 530% over the last year. That means its earnings are split among a greater number of shares. 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 Pacific Radiance's EPS by clicking here.

How Is Dilution Impacting Pacific Radiance's Earnings Per Share (EPS)?

Pacific Radiance was losing money three years ago. On the bright side, in the last twelve months it grew profit by 3,274%. But EPS was less impressive, up only 2,109% in that time. So you can see that the dilution has had a fairly significant impact on shareholders.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So Pacific Radiance shareholders will want to see that EPS figure continue to increase. However, if its profit increases while its earnings per share stay flat (or even fall) then shareholders might not see much benefit. For that reason, you could say that EPS is more important that net income in the long run, assuming the goal is to assess whether a company's share price might grow.

Our Take On Pacific Radiance's Profit Performance

In conclusion, Pacific Radiance has weak cashflow relative to earnings, which indicates lower quality earnings, and the dilution means its earnings per share growth is weaker than its profit growth. On reflection, the above-mentioned factors give us the strong impression that Pacific Radiance'sunderlying earnings power is not as good as it might seem, based on the statutory profit numbers. If you want to do dive deeper into Pacific Radiance, you'd also look into what risks it is currently facing. To that end, you should learn about the 3 warning signs we've spotted with Pacific Radiance (including 2 which are potentially serious).

Our examination of Pacific Radiance 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 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.