Shanghai Zhonggu Logistics Co., Ltd. (SHSE:603565) recently posted soft earnings but shareholders didn't react strongly. Our analysis suggests that they may be missing some concerning details underlying the profit numbers.
Examining Cashflow Against Shanghai Zhonggu Logistics' 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). 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. This ratio tells us how much of a company's profit is not backed by free cashflow.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
Shanghai Zhonggu Logistics has an accrual ratio of 0.43 for the year to December 2023. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. Even though it reported a profit of CN¥1.72b, a look at free cash flow indicates it actually burnt through CN¥566m in the last year. It's worth noting that Shanghai Zhonggu Logistics generated positive FCF of CN¥1.6b a year ago, so at least they've done it in the past. Having said that, there is more to the story. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.
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.
The Impact Of Unusual Items On Profit
Given the accrual ratio, it's not overly surprising that Shanghai Zhonggu Logistics' profit was boosted by unusual items worth CN¥770m 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. Which is hardly surprising, given the name. Shanghai Zhonggu Logistics had a rather significant contribution from unusual items relative to its profit to December 2023. 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 Shanghai Zhonggu Logistics' Profit Performance
Summing up, Shanghai Zhonggu Logistics received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. On reflection, the above-mentioned factors give us the strong impression that Shanghai Zhonggu Logistics'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 Shanghai Zhonggu Logistics at this point in time. Every company has risks, and we've spotted 2 warning signs for Shanghai Zhonggu Logistics (of which 1 is potentially serious!) you should know about.
Our examination of Shanghai Zhonggu Logistics 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. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. 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.