Why Nam Cheong's Earnings Quality Raises Red Flags for Investors: A Cash Flow and Accrual Accounting Alert

Investors in Nam Cheong Limited (SGX:1MZ) are being lured by a facade of growth that crumbles under scrutiny. While the company’s reported earnings show headline-grabbing increases, a deeper dive into its financials reveals a troubling disconnect between statutory profits and cash flow sustainability, exacerbated by an accrual ratio of 1.00 and a reliance on RM441 million in unusual items to prop up results. This article exposes why these red flags should give investors pause—and why the company’s future profitability may be far weaker than its glossy earnings suggest.

The Cash Flow-Cash Gap: Why “Profit” Isn’t Profit

Let’s start with the basics. Nam Cheong reported SGD 785.2 million in net income for the year ending December 2024, a 348% year-over-year surge. But here’s the catch: only SGD 92.8 million of that came from free cash flow. The rest? It’s a mirage.

The accrual ratio—a measure of how much reported profits exceed cash generation—stands at 1.00, meaning Nam Cheong’s non-cash accounting accruals now fully offset its free cash flow. This is a critical warning sign. Academic research, including a landmark 2014 study by Lewellen and Resutek, has shown that companies with high accrual ratios (above zero) tend to underperform in subsequent years. Nam Cheong’s ratio isn’t just elevated—it’s signaling a systemically weak cash conversion model.

The numbers are stark:
- Operating cash flow (SGD 190 million) is dwarfed by capital expenditures (SGD 98 million) and debt repayments (SGD 37 million), leaving a net cash position of SGD 120 million—a precarious cushion for a company reliant on volatile shipbuilding contracts.
- Free cash flow per share (SGD 0.29) is a fraction of its EPS (SGD 2.36), revealing a stark mismatch between earnings and the cash needed to sustain operations or invest in growth.

The Role of “Unusual Items”: One-Time Gains, Permanent Risks

The company’s reported profits are further inflated by RM441 million in unusual items over the last 12 months—a figure equivalent to 56% of its total net income. This raises two critical questions:
1. What exactly are these gains?
Nam Cheong has not disclosed specifics, but given its shipbuilding business, they could include asset sales, insurance payouts, or project windfalls. Whatever their source, they are likely non-recurring.
2. What happens when the one-time gains vanish?
The answer is clear: profitability collapses. In Q1 2024, Nam Cheong’s attributable profit plunged 95%, triggering a 3% share price drop. The Q1 2025 results (not yet fully disclosed) likely continue this trend, with EPS dropping to SGD 0.08 from SGD 3.80 a year earlier.

The Accrual Accounting Risk: A Recipe for Future Earnings Disappointments

The accrual ratio isn’t just a technicality—it’s a harbinger of trouble. Here’s why:
- Earnings quality erosion: When accruals dominate profits, investors can’t trust reported results. Nam Cheong’s gross margin of 64% in 2024 seems impressive until you realize it’s inflated by one-off gains and unsustainable cost controls.
- Balance sheet strain: Shares outstanding surged 308% in 2024, diluting existing investors’ stakes. Meanwhile, debt repayments remain high, and the company’s SGD 120 million cash pile offers little buffer for a sector hit by global shipping downturns.
- Structural underperformance: Nam Cheong’s ROE (46%) looks strong, but it’s inflated by low equity (due to share dilution) and accrual-driven profits. The reality? Its net profit margin fell to 38% in 2024, down from 44% in 2023.

Implications for Investors: Why Caution Trumps Greed

The data paints a clear picture:
1. Overvalued stock: The disconnect between earnings and cash flow suggests Nam Cheong’s valuation is built on shaky ground.
2. Sector risks: Shipbuilding demand is cyclical, and with global economic uncertainty, Nam Cheong’s reliance on project-based revenue leaves it vulnerable.
3. Lack of transparency: The absence of details on unusual items and the accrual-heavy accounting raise governance concerns.

Conclusion: Proceed with Extreme Caution

Nam Cheong’s financials are a textbook case of “earnings without cash”—a recipe for investor disappointment. While short-term gains may tempt traders, the red flags—high accrual ratios, reliance on one-time boosts, and volatile cash flows—point to a company whose reported success is far from sustainable.

For investors, the message is clear: avoid Nam Cheong until it demonstrates a cash flow model that matches its earnings claims. Until then, its shares are best left on the sidelines.

Data sources: Nam Cheong annual reports, SGX filings, and market analysis.