Xinlei Compressor Co., Ltd. (SZSE: 301317) recently reported solid earnings, but investor sentiment remained tepid, signaling concerns beneath the surface. After analyzing the company’s financials, it becomes clear that investors may be focusing on underlying weaknesses that suggest the profit figures might not be as strong as they first appear.
Analyzing Cash Flow vs. Earnings
One key metric that often raises red flags is the *accrual ratio*, a financial indicator that helps assess how well a company converts its profits into free cash flow (FCF). The accrual ratio is calculated by subtracting FCF from profit, then dividing that result by the company’s average operating assets during the period. A negative accrual ratio is generally seen as favorable, indicating the company is generating cash efficiently, while a positive ratio could signal potential issues.
For the year ending in September 2024, Xinlei Compressor reported an accrual ratio of 1.34—a worrying figure. Statistically, this suggests a negative outlook for future earnings. More troubling, despite posting a profit of CN¥61.7 million, the company’s cash flow story was much bleaker: it actually burned through CN¥621 million in the past year, highlighting a stark disconnect between reported profit and the company’s cash position.
After a year of negative free cash flow, investors might understandably be concerned about the implications of this ongoing cash burn. While a positive accrual ratio isn’t necessarily a cause for alarm on its own, the level here suggests that the company may be relying on accounting adjustments or one-off gains to prop up its earnings.
The Impact of Unusual Items on Profit
A closer look reveals that Xinlei Compressor’s profit was artificially inflated by unusual items, which contributed CN¥27 million to the bottom line last year. These non-recurring items are often considered unreliable sources of profit, as they don’t repeat in future periods. Such contributions can distort the true earnings power of a company, and in this case, they likely explain the weak accrual ratio. While higher profit is always welcome, it’s important to scrutinize whether these gains are sustainable or simply the result of temporary factors.
Given that unusual items made up a significant portion of the profit for the year ending in September 2024, they likely skewed the company’s reported earnings, making them appear more robust than they actually are. This raises questions about the sustainability of Xinlei Compressor’s earnings going forward.
Our View on Xinlei Compressor’s Profitability
Although Xinlei Compressor posted a profit, the weak accrual ratio and heavy reliance on unusual items suggest that the company’s underlying earnings power may not be as strong as the numbers imply. The substantial cash burn further complicates the outlook, signaling potential risks for investors who may be overestimating the sustainability of its profitability based on statutory earnings alone.
In light of these factors, we remain cautious about the company’s financial health. Investors should be aware of the risks associated with Xinlei Compressor’s earnings and consider other factors before making an investment decision. For those looking deeper into the company’s prospects, we have identified three warning signs to monitor closely—one of which is particularly concerning.
While these findings raise doubts, there are other ways to gauge the company’s potential, such as evaluating its return on equity or looking at insider activity for signals of confidence. Nonetheless, based on the current financials, we remain skeptical about Xinlei Compressor’s ability to sustain its earnings in the long term.
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