The ROE league table

Financial Article 539 by Edward Rizzo - May 24, 2018

In my weekly column earlier this month I published an article on the dividend league table. Regular readers of my weekly column are accustomed to the annual league tables published in May following the end of the annual reporting season for most companies listed on the regulated Main Market of the Malta Stock Exchange.

The main objective of many local investors is that of generating an income stream from the various securities within their investment portfolio. Although many investors still have a general tendency to favour bonds, a growing number of investors are increasing their exposure to dividend-yielding equities in their portfolios. However, there are a number of factors that investors ought to consider before investing in equities and while some investors are generally oriented towards steady and sustainable dividends (hence the importance of the dividend league table), other investors pay less attention to dividends and prefer to seek capital growth prospects. In this case, other financial metrics need to be considered such as the return on equity, the Enterprise Value to EBITDA multiple, the price to earnings ratio and the price to net asset value.

The use of these ratios varies depending on the economic sector in which the companies operate. By way of example, for those companies that have a high level of depreciation and amortization, the Enterprise Value to EBITDA multiple is more commonly applied across international financial markets than the price to earnings multiple.

Irrespective of the economic sector, the Return on Equity is a very important indicator since it measures the profit generated by a company from the amount of money invested by shareholders. This ratio is calculated by dividing the profit after tax figure by the average level of shareholders’ funds.

I have been publishing the ROE league table for the past two years and the updated ROE table enables investors to gauge those companies offering the highest returns and also helps to compare changes in returns from one year to the next.

The table only shows those companies that generated double-digit returns on equity during their last financial year.

Many investors would be surprised to note that MIDI plc ranks in first place with a ROE of 27% during 2017. As I reported last week, MIDI’s financial performance was boosted by a €26.3 million contribution from Mid Knight Holdings Limited following a revaluation of “The Centre” to €95 million compared to a value of €35.4 million as at the end of 2016. The significant revaluation of this investment helped MIDI report a net profit for the year of €20.8 million. MIDI should again report a healthy ROE for 2018 as a large number of the Q2 apartments are expected to be delivered to their new owners during the course of the year. The projected ROE could be calculated once MIDI publishes its updated Financial Analysis Summary in the coming weeks.

Another three property companies also feature within the ROE league table as these all benefited from one-off revaluations in line with the nature of their business activity.

The return on equity for the newcomer Trident Estates plc of 16.3% is based on the pro-forma figures included in the Prospectus published a few months ago in connection with its spin-off from Simonds Farsons Cisk plc. These financial statements had included a sizeable fair value gain and as such, the return on equity should decline to below the 10% level until subsequent property revaluations can take place in future years.

Malta Properties Company plc accounted for a much larger positive adjustment in the fair value of property of €4.97 million in 2017 compared to €1.7 million in the previous comparable period. This helped the net profit figure for the year rise to a record of €4.67 million thereby boosting the ROE to 12.1%. Likewise, Malita Investments plc posted a fair value gain of €11.3 million in relation to the Parliament Building and the Open Air Theatre in Valletta (which until 31 December 2016 were still valued at cost) and the fair values of the Malta International Airport and Valletta Cruise Port sites increased by an aggregate of €5.38 million in 2017. These sizeable revaluations boosted Malita’s net profit in 2017 to nearly €13 million compared to €6.42 million in 2016 and helped the ROE to rise to 11.2% from 5.9% in 2016.

Malta International Airport plc has been one of the most consistent companies in recent years generating among the highest ROE’s compared to other companies listed on the Malta Stock Exchange. In fact, for the past 7 years the airport operator generated an annual return on equity in excess of 20%. In 2017, MIA’s net profit increased to a new record of €24.2 million giving a ROE of 26.7% thus achieving a second placing in the league table. MIA’s positive financial performance is expected to continue during the current year as the company had projected that its net profit would exceed €28 million in 2018 representing an increase of 16% over the 2017 figure on the back on sustained growth in passenger traffic.

In view of the ambitious investment programme in the year ahead following approval of the masterplan, MIA has been retaining a large proportion of annual profits in order to partly fund the upcoming developments. The consistent ROE of above 20% should also be viewed in the context of the sizeable increase in shareholders’ funds via retained earnings. It is worth nothing that had MIA opted for a more aggressive dividend payout and instead resorted to a larger proportion of debt funding for the investment programme, the ROE could continue to rise further as a result of the lower level of shareholders’ funds.

PG plc has a financial year that ends on 30 April and the ROE of 26.4% (placing the company in third position) is based on the forecast provided by the company for the year ended 30 April 2018. PG had indicated in the prospectus published last year that it expects to register a profit after tax of €8.4 million for the 2017/18 financial year representing an increase of 12.9% over the prior year. The actual results are expected to be published by mid-August 2018. It would be helpful if the company would also give indicative figures for certain key performance indicators for their financial year to 30 April 2019 to assist the investing community in assessing the sustainability of the company’s performance.

GO plc has also been among the more consistent positive performers in recent years. Although the ROE eased to 16.1% in 2017 from 19.1% the previous year, this was due to the recognition in 2016 of a one-time gain of €6.08 million related to the value of GO’s investment in Cablenet which was not repeated in 2017. In fact, although the net profit in 2017 amounted to €16.7 million compared to €20.3 million in 2016, the Group’s earnings before interest, tax, depreciation and amortization (EBITDA) improved by 6.4% during 2017 to €65.6 million. GO plc is also likely to remain among those companies achieving double-digit returns for shareholders.

Many investors may also be surprised to note that for the second successive year, GlobalCapital plc features among the top performers from a ROE perspective. The group posted a significant increase in net profit to €3.17 million in 2017 from €1.85 million in 2016 mainly driven by the performance of the life insurance business. The ROE increased from 16.5% in 2016 to 19% in 2017 despite the €5 million rights issue during the course of 2016. Meanwhile, GlobalCapital had announced earlier this year that in April 2018 it had to submit an application to the Listing Authority in relation to a €6 million rights issue. Should this rights issue take place in the near term, it may dampen the ROE in the coming years unless the group’s profitability continues to rise.

For the second successive year, Simonds Farsons Cisk plc generated a return on equity in excess of 10%. Last week Farsons published its 2017/18 financial statements showing a 13.4% increase in net profit to a fresh record level of €13.8 million. The ROE increased to 12.5% from 10.4% in the previous financial year not only due to the additional profit generated but also as a result of the lower level of shareholders’ funds following the spin-off of Trident Estates plc. Since the average level of shareholders’ funds is taken in the calculation of the ROE and the spin-off of Trident Estates took place during the course of the last financial year, the ROE should improve further during the 2018/19 financial year assuming Farsons retains this level of profitability.

Two of the companies that have disappointed the market from a ROE perspective are Medserv plc and RS2 Software plc. Medserv plc had registered a return on equity of above 40% during its 2015 financial year while the ROE of RS2 Software in 2015 was 18.8%. Both companies have since registered much lower returns due to various reasons and investors will be attentive to future announcements by both companies to gauge whether they can achieve more meaningful returns in the immediate future.

While the dividend yield and the return on equity are important financial metrics that investors ought to consider before contemplating an investment in equities, there are various other ratios and factors that need to be taken into consideration. Moreover, since these ratios are mainly based on historical figures, the more important aspect is the sustainability of a company’s financial performance and shareholder returns in future years. While a few companies have started publishing financial guidance to the market mainly as a result of their obligations under the Listing Policies due to the issuance of bonds, the other equity issuers should also strive to have a policy of providing a more open line of communication and publish projected financial indicators on a regular basis.

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Rizzo, Farrugia & Co. (Stockbrokers) Ltd, “RFC”, is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the company/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. RFC, its directors, the author of this report, other employees or RFC on behalf of its clients, have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent, and may also have other business relationships with the company/s. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither RFC, nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.