Weak Statutory Earnings May Not Tell The Whole Story For RLX Technology (NYSE:RLX)

Despite RLX Technology Inc.'s (NYSE:RLX) recent earnings report having lackluster headline numbers, the market responded positively. Sometimes, shareholders are willing to ignore soft numbers with the hope that they will improve, but our analysis suggests this is unlikely for RLX Technology.

Check out our latest analysis for RLX Technology

A Closer Look At RLX Technology'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. 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. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

RLX Technology has an accrual ratio of 0.35 for the year to December 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. In fact, it had free cash flow of CN¥487m in the last year, which was a lot less than its statutory profit of CN¥1.44b. RLX Technology shareholders will no doubt be hoping that its free cash flow bounces back next year, since it was down over the last twelve months.

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 RLX Technology's Profit Performance

As we discussed above, we think RLX Technology's earnings were not supported by free cash flow, which might concern some investors. For this reason, we think that RLX Technology's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. Sadly, its EPS was down over the last twelve months. 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. So while earnings quality is important, it's equally important to consider the risks facing RLX Technology at this point in time. Case in point: We've spotted 2 warning signs for RLX Technology you should be mindful of and 1 of these shouldn't be ignored.

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

What are the risks and opportunities for RLX Technology?

NYSE:RLX

RLX Technology

RLX Technology Inc., together with its subsidiaries, researchers, develops, manufactures, distributes, and sells e-vapor products in the People's Republic of China.Show more

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Rewards

• Trading at 50% below our estimate of its fair value

• Earnings are forecast to grow 8.43% per year

Risks

• High level of non-cash earnings

• Volatile share price over the past 3 months

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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.