Divfex Berhad (KLSE:DFX) recently posted soft earnings but shareholders didn't react strongly. We did some digging, and we believe that investors are missing some worrying factors underlying the profit figures.
Check out our latest analysis for Divfex Berhad
Zooming In On Divfex Berhad's Earnings
As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. The accrual ratio subtracts the FCF from the profit for a given period, and divides the result by the average operating assets of the company over that time. This ratio tells us how much of a company's profit is not backed by free cashflow.
Therefore, it's actually considered a good thing when a company has a negative accrual ratio, but a bad thing if its accrual ratio is positive. 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. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.
For the year to September 2024, Divfex Berhad had an accrual ratio of 0.73. As a general rule, that bodes poorly for future profitability. To wit, the company did not generate one whit of free cashflow in that time. Over the last year it actually had negative free cash flow of RM6.8m, in contrast to the aforementioned profit of RM4.72m. It's worth noting that Divfex Berhad generated positive FCF of RM12m a year ago, so at least they've done it in the past. Importantly, we note an unusual tax situation, which we discuss below, has impacted the accruals ratio. This would partially explain why the accrual ratio was so poor. The good news for shareholders is that Divfex Berhad's accrual ratio was much better last year, so this year's poor reading might simply be a case of a short term mismatch between profit and FCF. Shareholders should look for improved cashflow relative to profit in the current year, if that is indeed the case.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Divfex Berhad.
An Unusual Tax Situation
Moving on from the accrual ratio, we note that Divfex Berhad profited from a tax benefit which contributed RM1.5m to profit. It's always a bit noteworthy when a company is paid by the tax man, rather than paying the tax man. Of course, prima facie it's great to receive a tax benefit. However, our data indicates that tax benefits can temporarily boost statutory profit in the year it is booked, but subsequently profit may fall back. Assuming the tax benefit is not repeated every year, we could see its profitability drop noticeably, all else being equal.