Should You Rely On ZTO Express (Cayman)'s (NYSE:ZTO) Earnings Growth?

Many investors consider it preferable to invest in profitable companies over unprofitable ones, because profitability suggests a business is sustainable. However, sometimes companies receive a one-off boost (or reduction) to their profit, and it's not always clear whether statutory profits are a good guide, going forward. This article will consider whether ZTO Express (Cayman)'s (NYSE:ZTO) statutory profits are a good guide to its underlying earnings.

We like the fact that ZTO Express (Cayman) made a profit of CN¥5.35b on its revenue of CN¥23.8b, in the last year. Happily, it has grown both its profit and revenue over the last three years, as you can see in the chart below.

View our latest analysis for ZTO Express (Cayman)

Of course, it is only sensible to look beyond the statutory profits and question how well those numbers represent the sustainable earnings power of the business. So this article aims to better understand ZTO Express (Cayman)'s underlying earnings power by taking a look at how dilution, and unusual items are impacting it, and considering how well those paper profits are being converted into cash flow. 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.

A Closer Look At ZTO Express (Cayman)'s 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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. The ratio shows us how much a company's profit exceeds its FCF.

As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.

Over the twelve months to September 2020, ZTO Express (Cayman) recorded an accrual ratio of 0.22. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. Even though it reported a profit of CN¥5.35b, a look at free cash flow indicates it actually burnt through CN¥56m in the last year. It's worth noting that ZTO Express (Cayman) generated positive FCF of CN¥1.9b 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.

In order to understand the potential for per share returns, it is essential to consider how much a company is diluting shareholders. As it happens, ZTO Express (Cayman) issued 9.4% more new shares over the last year. Therefore, each share now receives a smaller portion of profit. 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. Check out ZTO Express (Cayman)'s historical EPS growth by clicking on this link.

How Is Dilution Impacting ZTO Express (Cayman)'s Earnings Per Share? (EPS)

As you can see above, ZTO Express (Cayman) has been growing its net income over the last few years, with an annualized gain of 106% over three years. But EPS was only up 87% per year, in the exact same period. And in the last year the company managed to bump profit up by 15%. But in comparison, EPS only increased by 16% over the same period. So you can see that the dilution has had a bit of an impact on shareholders. Therefore, the dilution is having a noteworthy influence on shareholder returns. And so, you can see quite clearly that dilution is influencing shareholder earnings.

Changes in the share price do tend to reflect changes in earnings per share, in the long run. So it will certainly be a positive for shareholders if ZTO Express (Cayman) can grow EPS persistently. 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 ZTO Express (Cayman)'s profit was boosted by unusual items worth CN¥696m 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. Which is hardly surprising, given the name. If ZTO Express (Cayman) doesn't see that contribution repeat, then all else being equal we'd expect its profit to drop over the current year.

Our Take On ZTO Express (Cayman)'s Profit Performance

In conclusion, ZTO Express (Cayman)'s 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. For the reasons mentioned above, we think that a perfunctory glance at ZTO Express (Cayman)'s statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about ZTO Express (Cayman) as a business, it's important to be aware of any risks it's facing. For instance, we've identified 2 warning signs for ZTO Express (Cayman) (1 is concerning) you should be familiar with.

In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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.

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This article by Simply Wall St is general in nature. 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.
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