ENECHANGE (TSE:4169) Shareholders Should Be Cautious Despite Solid Earnings
Shareholders were pleased with the recent earnings report from ENECHANGE Ltd. (TSE:4169). Despite this, we feel that there are some reasons to be cautious with these earnings.
Zooming In On ENECHANGE'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. In plain english, this ratio subtracts FCF from net profit, and divides that number by the company's average operating assets over that period. 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. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".
ENECHANGE has an accrual ratio of 0.46 for the year to September 2026. Statistically speaking, that's a real negative for future earnings. To wit, the company did not generate one whit of free cashflow in that time. In the last twelve months it actually had negative free cash flow, with an outflow of JP¥225m despite its profit of JP¥549.0m, mentioned above. Coming off the back of negative free cash flow last year, we imagine some shareholders might wonder if its cash burn of JP¥225m, this year, indicates high risk. 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.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of ENECHANGE.
An Unusual Tax Situation
In addition to the notable accrual ratio, we can see that ENECHANGE received a tax benefit of JP¥246m. This is meaningful because companies usually pay tax rather than receive tax benefits. We're sure the company was pleased with its 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. In the likely event the tax benefit is not repeated, we'd expect to see its statutory profit levels drop, at least in the absence of strong growth.
Our Take On ENECHANGE's Profit Performance
This year, ENECHANGE couldn't match its profit with cashflow. If the tax benefit is not repeated, then profit would drop next year, all else being equal. For the reasons mentioned above, we think that a perfunctory glance at ENECHANGE's statutory profits might make it look better than it really is on an underlying level. If you'd like to know more about ENECHANGE as a business, it's important to be aware of any risks it's facing. Case in point: We've spotted 3 warning signs for ENECHANGE you should be mindful of and 1 of them is a bit unpleasant.
In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. 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 with high insider ownership.
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