Fajarbaru Builder Group Bhd.’s (KLSE:FAJAR) robust earnings report didn’t manage to move the market for its stock. Our analysis suggests that this might be because shareholders have noticed some concerning underlying factors.
Check out our latest analysis for Fajarbaru Builder Group Bhd
One key financial ratio used to measure how well a company converts its profit to free cash flow (FCF) is the accrual ratio. 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. To quote a 2014 paper by Lewellen and Resutek, “firms with higher accruals tend to be less profitable in the future”.
Fajarbaru Builder Group Bhd has an accrual ratio of 0.25 for the year to September 2024. We can therefore deduce that its free cash flow fell well short of covering its statutory profit. In the last twelve months it actually had negative free cash flow, with an outflow of RM28m despite its profit of RM59.6m, mentioned above. We also note that Fajarbaru Builder Group Bhd’s free cash flow was actually negative last year as well, so we could understand if shareholders were bothered by its outflow of RM28m.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Fajarbaru Builder Group Bhd.
Fajarbaru Builder Group Bhd’s accrual ratio for the last twelve months signifies cash conversion is less than ideal, which is a negative when it comes to our view of its earnings. Because of this, we think that it may be that Fajarbaru Builder Group Bhd’s statutory profits are better than its underlying earnings power. On the bright side, the company showed enough improvement to book a profit this year, after losing money last year. 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. So while earnings quality is important, it’s equally important to consider the risks facing Fajarbaru Builder Group Bhd at this point in time. For example, we’ve found that Fajarbaru Builder Group Bhd has 4 warning signs (2 are a bit concerning!) that deserve your attention before going any further with your analysis.
