6 days ago
Solid Earnings May Not Tell The Whole Story For Rex Industry Berhad (KLSE:REX)
Rex Industry Berhad's (KLSE:REX) robust recent earnings didn't do much to move the stock. We think this is due to investors looking beyond the statutory profits and being concerned with what they see.
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In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). 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'.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. 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. Notably, there is some academic evidence that suggests that a high accrual ratio is a bad sign for near-term profits, generally speaking.
Rex Industry Berhad has an accrual ratio of 0.26 for the year to March 2025. Unfortunately, that means its free cash flow fell significantly short of its reported profits. Even though it reported a profit of RM6.33m, a look at free cash flow indicates it actually burnt through RM19m in the last year. It's worth noting that Rex Industry Berhad generated positive FCF of RM4.1m a year ago, so at least they've done it in the past. The good news for shareholders is that Rex Industry 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 Rex Industry Berhad.
Rex Industry Berhad didn't convert much of its profit to free cash flow in the last year, which some investors may consider rather suboptimal. Therefore, it seems possible to us that Rex Industry Berhad's true underlying earnings power is actually less than its statutory profit. 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 Rex Industry Berhad at this point in time. To that end, you should learn about the 3 warning signs we've spotted with Rex Industry Berhad (including 1 which is concerning).
Today we've zoomed in on a single data point to better understand the nature of Rex Industry Berhad's profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks with significant insider holdings to be useful.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
