China Mobile Earnings Quality Analysis

May. 6.14 | About: China Mobile (CHL)

Summary

CHL shows improving earnings quality as reflected in its balance-sheet-based accruals ratio and cash-flow-statement-based accruals ratio.

Earnings quality relates to how useful financial statements are in forecasting future cash flows.

While earnings quality improved in 2013, CHL’s profit decreased.

For readers who are unfamiliar with what China Mobile (NYSE:CHL) does and the scope it operates on, two sentences from the company's most recent annual report (released in late April) provide a succinct introduction:

Based on publicly available information, we are the leading provider of mobile telecommunications services in Mainland China and the largest provider of mobile telecommunications services in the world as measured by total number of customers as of December 31, 2013. As of the same date, our total number of customers reached approximately 767.2 million, representing approximately 62.1% of all mobile customers in Mainland China.

These are impressive figures. However, the company also notes in its annual report that it lost market share in 2013. Also, net income decreased in 2013 for the first time in the past four years. Below is a chart from CHL's most recent annual report that shows this. The color-coding is my own addition. Years in which a figure increased over the previous year are marked in green and years in which a figure decreased over the previous year are marked in red. The chart highlights how revenue has consistently increased, while profit from operations, net income, and diluted earnings per share recently began decreasing.

Click to enlarge

Financial statement figures such as these are all quite interesting, but in this article, I would like to take a step back and analyze the earnings quality of the statements themselves. Earnings quality here is in reference to how accurately the financial statements portray operating performance. This has implications for earnings persistence and sustainability, or in other words, how useful the financial statements are for predicting future earnings. Earnings quality can deteriorate because of accounting decisions or simply due to the nature of accrual accounting. Considerable estimation goes into putting together accrual-based financial statements, yet it is the norm for public companies.

Therefore, the calculations described below seek to identify the amount of accruals and discretion that are embedded in a company's financial statements. Specifically, I will discuss how the calculation of two ratios, the balance-sheet-based accruals ratio and the cash-flow-statement-based accruals ratio, show that CHL's earnings quality has shown an improvement. This is an important conclusion considering the decline in the company's profitability.

Balance-Sheet-Based Accruals Ratio

To find the balance-sheet-based accruals ratio, net operating assets are first calculated. NOA equals [(total assets - cash and equivalents) - (total liabilities - total debt)]. Aggregate accruals for a given year are NOA in that year minus NOA from the previous year. To create a ratio, aggregate accruals are divided by average NOA for those two years.

Cash-Flow-Statement-Based Accruals Ratio

Aggregate accruals from the cash flow statement equal [Net income - (operating cash flows + investing cash flows)]. To calculate the cash-flow-statement-based accruals ratio, this figure is then divided by the same average NOA described above.

The cash-flow-statement-based accruals ratio and the balance-sheet-based accruals ratio may not be equal, but the trend revealed should be similar.

Conclusion

The ratios I have calculated for CHL are presented below and the figures used in the calculations are included in the appendix after the conclusion.

2013

2012

2011

Aggregate Balance Sheet Accruals (million RMB)

67,961

89,788

70,435

Balance Sheet Accruals Ratio

9.46%

14.05%

12.60%

Cash Flow Statement Aggregate Accruals (million RMB)

62,634

70,137

68,470

Cash Flow Statement Accruals Ratio

8.72%

10.97%

12.24%

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Summarizing the results, the cash flow statement accruals ratio decreased consistently from 2011 to 2013, while the balance sheet accruals ratio increase in 2012 but then decreased in 2013 to a level lower than in 2011. This same trend of a slight increase in 2012, but a decrease in 2013 that resulted in a lower figure than in 2011 was also followed by the balance sheet aggregate accruals and the cash flow statement accruals.

This implies that CHL's earnings quality displays improvement from 2012 to 2013 and also overall from 2011 to 2013.

In closing, my calculations and results are correct to the best of my knowledge, yet this does not rule out the possibility of there being errors. As always, readers should perform their own analysis and verification, as well as understand that the ratios described in this article generally do not serve as a standalone reason to invest or not invest in a given stock.

Appendix

Figures used in calculations (from CHL annual reports; fiscal year ends December 31):

2013

2012

2011

2010

Total Assets

1,167,392

1,052,109

952,558

861,935

Cash and cash equivalents

44,931

70,906

86,259

87,543

Total Liabilities

376,668

326,800

302,139

284,532

Total Debt

6,349

29,778

30,233

34,098

NOA

752,142

684,181

594,393

523,958

Aggregate Balance Sheet Accruals

67,961

89,788

70,435

Balance Sheet Accruals Ratio

9.46%

14.05%

12.60%

Net Income

121,692

129,274

125,870

119,640

CFO

224,985

230,709

226,756

231,379

CFI

-165,927

-171,572

-169,356

-171,572

Cash Flow Statement Aggregate Accruals

62,634

70,137

68,470

59,833

Cash Flow Statement Accruals Ratio

8.72%

10.97%

12.24%

Click to enlarge

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.