Union Gas Holdings' (SGX:1F2) Problems Go Beyond Poor Profit

Union Gas Holdings Limited's (SGX:1F2) stock wasn't much affected by its recent lackluster earnings numbers. We did some analysis and found some concerning details beneath the statutory profit number.

Check out our latest analysis for Union Gas Holdings

Examining Cashflow Against Union Gas Holdings' Earnings

Many investors haven't heard of the accrual ratio from cashflow, but it is actually a useful measure of how well a company's profit is backed up by free cash flow (FCF) during a given period. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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".

Union Gas Holdings has an accrual ratio of 0.33 for the year to June 2022. 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. Even though it reported a profit of S$3.00m, a look at free cash flow indicates it actually burnt through S$13m in the last year. It's worth noting that Union Gas Holdings generated positive FCF of S$16m a year ago, so at least they've done it in the past. Having said that, there is more to consider. We must also consider the impact of unusual items on statutory profit (and thus the accrual ratio), as well as note the ramifications of the company issuing new shares.

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

To understand the value of a company's earnings growth, it is imperative to consider any dilution of shareholders' interests. Union Gas Holdings expanded the number of shares on issue by 39% over the last year. That means its earnings are split among a greater number of shares. To celebrate net income while ignoring dilution is like rejoicing because you have a single slice of a larger pizza, but ignoring the fact that the pizza is now cut into many more slices. Check out Union Gas Holdings' historical EPS growth by clicking on this link.

How Is Dilution Impacting Union Gas Holdings' Earnings Per Share (EPS)?

Unfortunately, Union Gas Holdings' profit is down 59% per year over three years. Even looking at the last year, profit was still down 92%. Sadly, earnings per share fell further, down a full 91% in that time. And so, you can see quite clearly that dilution is having a rather significant impact on shareholders.

In the long term, if Union Gas Holdings' earnings per share can increase, then the share price should too. But on the other hand, we'd be far less excited to learn profit (but not EPS) was improving. 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.

The Impact Of Unusual Items On Profit

Given the accrual ratio, it's not overly surprising that Union Gas Holdings' profit was boosted by unusual items worth S$8.9m in the last twelve months. We can't deny that higher profits generally leave us optimistic, but we'd prefer it if the profit were to be sustainable. When we crunched the numbers on thousands of publicly listed companies, we found that a boost from unusual items in a given year is often not repeated the next year. And that's as you'd expect, given these boosts are described as 'unusual'. Union Gas Holdings had a rather significant contribution from unusual items relative to its profit to June 2022. All else being equal, this would likely have the effect of making the statutory profit a poor guide to underlying earnings power.

Our Take On Union Gas Holdings' Profit Performance

In conclusion, Union Gas Holdings' weak accrual ratio suggested its statutory earnings have been inflated by the unusual items. The dilution means the results are weaker when viewed from a per-share perspective. On reflection, the above-mentioned factors give us the strong impression that Union Gas Holdings'underlying earnings power is not as good as it might seem, based on the statutory profit numbers. So while earnings quality is important, it's equally important to consider the risks facing Union Gas Holdings at this point in time. Be aware that Union Gas Holdings is showing 3 warning signs in our investment analysis and 1 of those is a bit concerning...

Our examination of Union Gas Holdings 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. 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.