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A lackluster earnings announcement from Mewah International Inc. (SGX:MV4) last week didn't sink the stock price. We think that investors are worried about some weaknesses underlying the earnings.
Examining Cashflow Against Mewah International'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. The ratio shows us how much a company's profit exceeds its FCF.
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. That is not intended to imply we should worry about a positive accrual ratio, but it's worth noting where the accrual ratio is rather high. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
Over the twelve months to December 2024, Mewah International recorded an accrual ratio of 0.24. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, which is hardly a good thing. Even though it reported a profit of US$38.8m, a look at free cash flow indicates it actually burnt through US$241m in the last year. It's worth noting that Mewah International generated positive FCF of US$185m a year ago, so at least they've done it in the past. 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. One positive for Mewah International shareholders is that it's accrual ratio was significantly better last year, providing reason to believe that it may return to stronger cash conversion in the future. As a result, some shareholders may be looking for stronger cash conversion in the current year.
Check out our latest analysis for Mewah International
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Mewah International.
How Do Unusual Items Influence Profit?
Unfortunately (in the short term) Mewah International saw its profit reduced by unusual items worth US$16m. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. When we analysed the vast majority of listed companies worldwide, we found that significant unusual items are often not repeated. And, after all, that's exactly what the accounting terminology implies. If Mewah International doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.