Yahoo Finance Franco-Nevada Corporation (TSE:FNV): Can It Deliver A Superior ROE To The Industry?
Franco-Nevada Corporation’s (TSX:FNV) most recent return on equity was a substandard 4.56% relative to its industry performance of 11.07% over the past year. FNV’s results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on FNV’s performance. Today I will look at how components such as financial leverage can influence ROE which may impact the sustainability of FNV’s returns. See our latest analysis for Franco-Nevada
Peeling the layers of ROE – trisecting a company’s profitability
Return on Equity (ROE) is a measure of Franco-Nevada’s profit relative to its shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. Generally speaking, a higher ROE is preferred; however, there are other factors we must also consider before making any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
Returns are usually compared to costs to measure the efficiency of capital. Franco-Nevada’s cost of equity is 17.41%. Since Franco-Nevada’s return does not cover its cost, with a difference of -12.85%, this means its current use of equity is not efficient and not sustainable. Very simply, Franco-Nevada 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. The other component, asset turnover, illustrates how much revenue Franco-Nevada can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be artificially increased through excessive borrowing, we should check Franco-Nevada’s historic debt-to-equity ratio. Currently, Franco-Nevada has no debt which means its returns are driven purely by equity capital. This could explain why Franco-Nevada’s’ ROE is lower than its industry peers, most of which may have some degree of debt in its business.
Next Steps:
ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. Franco-Nevada’s ROE is underwhelming relative to the industry average, and its returns were also not strong enough to cover its own cost of equity. However, ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of returns, which has headroom to increase further. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Franco-Nevada, I’ve compiled three fundamental aspects 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 Franco-Nevada 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 Franco-Nevada is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Franco-Nevada? 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.
