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Despite posting some strong earnings, the market for Nam Cheong Limited's (SGX:1MZ) stock hasn't moved much. We did some digging, and we found some concerning factors in the details.
View our latest analysis for Nam Cheong
Zooming In On Nam Cheong'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. 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. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.
That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
Over the twelve months to September 2024, Nam Cheong recorded an accrual ratio of 1.24. That means it didn't generate anywhere near enough free cash flow to match its profit. Statistically speaking, that's a real negative for future earnings. To wit, it produced free cash flow of RM17m during the period, falling well short of its reported profit of RM739.9m. Notably, Nam Cheong had negative free cash flow last year, so the RM17m it produced this year was a welcome improvement.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Nam Cheong.
Our Take On Nam Cheong's Profit Performance
As we have made quite clear, we're a bit worried that Nam Cheong didn't back up the last year's profit with free cashflow. For this reason, we think that Nam Cheong's statutory profits may be a bad guide to its underlying earnings power, and might give investors an overly positive impression of the company. The silver lining is that its EPS growth over the last year has been really wonderful, even if it's not a perfect measure. The goal of this article has been to assess how well we can rely on the statutory earnings to reflect the company's potential, but there is plenty more to consider. If you'd like to know more about Nam Cheong as a business, it's important to be aware of any risks it's facing. When we did our research, we found 3 warning signs for Nam Cheong (1 shouldn't be ignored!) that we believe deserve your full attention.