Shareholders didn't seem to be thrilled with Hunan Airbluer Environmental Protection Technology Co., Ltd.'s (SZSE:301259) recent earnings report, despite healthy profit numbers. Our analysis suggests they may be concerned about some underlying details.

View our latest analysis for Hunan Airbluer Environmental Protection Technology

A Closer Look At Hunan Airbluer Environmental Protection Technology's 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 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.

For the year to June 2022, Hunan Airbluer Environmental Protection Technology had an accrual ratio of 0.48. As a general rule, that bodes poorly for future profitability. And indeed, during the period the company didn't produce any free cash flow whatsoever. Even though it reported a profit of CN¥67.1m, a look at free cash flow indicates it actually burnt through CN¥116m in the last year. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of CN¥116m, this year, indicates high risk. However, that's not all there is to consider. We can see that unusual items have impacted its statutory profit, and therefore the accrual ratio.

Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Hunan Airbluer Environmental Protection Technology.

The Impact Of Unusual Items On Profit

The fact that the company had unusual items boosting profit by CN¥7.8m, in the last year, probably goes some way to explain why its accrual ratio was so weak. 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. And that's as you'd expect, given these boosts are described as 'unusual'. Assuming those unusual items don't show up again in the current year, we'd thus expect profit to be weaker next year (in the absence of business growth, that is).

Our Take On Hunan Airbluer Environmental Protection Technology's Profit Performance

Summing up, Hunan Airbluer Environmental Protection Technology received a nice boost to profit from unusual items, but could not match its paper profit with free cash flow. For the reasons mentioned above, we think that a perfunctory glance at Hunan Airbluer Environmental Protection Technology's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about Hunan Airbluer Environmental Protection Technology as a business, it's important to be aware of any risks it's facing. To that end, you should learn about the 2 warning signs we've spotted with Hunan Airbluer Environmental Protection Technology (including 1 which is a bit concerning).

Our examination of Hunan Airbluer Environmental Protection Technology 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. 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. 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.