Stock Analysis

Is True North Commercial Real Estate Investment Trust's (TSE:TNT.UN) ROE Of 12.90% Sustainable?

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TSX:TNT.UN
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With an ROE of 12.90%, True North Commercial Real Estate Investment Trust (TSX:TNT.UN) returned in-line to its own industry which delivered 10.26% over the past year. But what is more interesting is whether TNT.UN can sustain this level of return. Sustainability can be gauged by a company’s financial leverage – the more debt it has, the higher ROE is pumped up in the short term, at the expense of long term interest payment burden. Let me show you what I mean by this. Check out our latest analysis for True North Commercial Real Estate Investment Trust

Breaking down Return on Equity

Firstly, Return on Equity, or ROE, is simply the percentage of last years’ earning against the book value of shareholders’ equity. It essentially shows how much the company can generate in earnings given the amount of equity it has raised. Investors seeking to maximise their return in the Office REITs industry may want to choose the highest returning stock. But this can be misleading as each company has different costs of equity and also varying debt levels, which could artificially push up ROE whilst accumulating high interest expense.

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 True North Commercial Real Estate Investment Trust, which is 8.43%. Given a positive discrepancy of 4.48% between return and cost, this indicates that True North Commercial Real Estate Investment Trust pays less for its capital than what it generates in return, which is a sign of capital efficiency. 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

TSX:TNT.UN Last Perf Feb 23rd 18
TSX:TNT.UN Last Perf Feb 23rd 18

The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue True North Commercial Real Estate Investment Trust can make from its asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. We can assess whether True North Commercial Real Estate Investment Trust is fuelling ROE by excessively raising debt. Ideally, True North Commercial Real Estate Investment Trust should have a balanced capital structure, which we can check by looking at the historic debt-to-equity ratio of the company. Currently the ratio stands at 147.36%, which is relatively balanced. This means True North Commercial Real Estate Investment Trust has not taken on excessive leverage, and its above-average ROE is driven by its ability to grow its profit without a significant debt burden.

TSX:TNT.UN Historical Debt Feb 23rd 18
TSX:TNT.UN Historical Debt Feb 23rd 18

Next Steps:

ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. True North Commercial Real Estate Investment Trust’s ROE is impressive relative to the industry average and also covers its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. Although ROE can be a useful metric, it is only a small part of diligent research.

For True North Commercial Real Estate Investment Trust, I've compiled three essential factors you should further research:

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

About TSX:TNT.UN

True North Commercial Real Estate Investment Trust

The REIT is an unincorporated, open-ended real estate investment trust established under the laws of the Province of Ontario.

The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.

Analysis AreaScore (0-6)
Valuation1
Future Growth0
Past Performance5
Financial Health1
Dividends5

Read more about these checks in the individual report sections or in our analysis model.

Solid track record established dividend payer.