Yahoo Finance Did AusNet Services Ltd (ASX:AST) Create Value For Shareholders?
AusNet Services Ltd (ASX:AST) outperformed the Electric Utilities industry on the basis of its ROE – producing a higher 8.20% relative to the peer average of 5.73% over the past 12 months. On the surface, this looks fantastic since we know that AST has made large profits from little equity capital; however, ROE doesn’t tell us if management have borrowed heavily to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether AST’s ROE is actually sustainable. See our latest analysis for AusNet Services
Peeling the layers of ROE – trisecting a company’s profitability
Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. An ROE of 8.20% implies A$0.08 returned on every A$1 invested. In most cases, a higher ROE is preferred; however, there are many other factors we must consider prior to making any investment decisions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for AusNet Services, which is 8.55%. This means AusNet Services’s returns actually do not cover its own cost of equity, with a discrepancy of -0.36%. This isn’t sustainable as it implies, very simply, that the company pays more for its capital than what it generates in return. ROE can be dissected into three distinct ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
Dupont Formula
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover shows how much revenue AusNet Services can generate with its current asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt AusNet Services currently has. At 220.33%, AusNet Services’s debt-to-equity ratio appears relatively high and indicates the above-average ROE is generated by significant leverage levels.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. AusNet Services exhibits a strong ROE against its peers, however it was not high enough to cover its own cost of equity this year. With debt capital in excess of equity, ROE may be inflated by the use of debt funding, raising questions over the sustainability of the company’s returns. Although ROE can be a useful metric, it is only a small part of diligent research.
For AusNet Services, there are three relevant factors you should further examine:
Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Valuation: What is AusNet Services worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether AusNet Services is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of AusNet Services? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
