TransAlta Renewables Inc.'s (TSE:RNW) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Coorect Its Share Price?

By
Simply Wall St
Published
November 04, 2020
TSX:RNW

Most readers would already be aware that TransAlta Renewables' (TSE:RNW) stock increased significantly by 11% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Specifically, we decided to study TransAlta Renewables' ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for TransAlta Renewables

How Do You Calculate Return On Equity?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for TransAlta Renewables is:

3.9% = CA$91m ÷ CA$2.3b (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. So, this means that for every CA$1 of its shareholder's investments, the company generates a profit of CA$0.04.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

TransAlta Renewables' Earnings Growth And 3.9% ROE

When you first look at it, TransAlta Renewables' ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 8.8% either. TransAlta Renewables was still able to see a decent net income growth of 11% over the past five years. We reckon that there could be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that TransAlta Renewables' reported growth was lower than the industry growth of 25% in the same period, which is not something we like to see.

past-earnings-growth
TSX:RNW Past Earnings Growth November 4th 2020

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for RNW? You can find out in our latest intrinsic value infographic research report.

Is TransAlta Renewables Making Efficient Use Of Its Profits?

TransAlta Renewables has a very high three-year median payout ratio of 235% suggesting that the company's shareholders are getting paid from more than just the company's earnings. However, this hasn't really hampered its ability to grow as we saw earlier. It would still be worth keeping an eye on that high payout ratio, if for some reason the company runs into problems and business deteriorates. To know the 3 risks we have identified for TransAlta Renewables visit our risks dashboard for free.

Additionally, TransAlta Renewables has paid dividends over a period of seven years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 96% over the next three years. The fact that the company's ROE is expected to rise to 10% over the same period is explained by the drop in the payout ratio.

Conclusion

Overall, we would be extremely cautious before making any decision on TransAlta Renewables. While no doubt its earnings growth is pretty respectable, its ROE and earnings retention is quite poor. So while the company has managed to grow its earnings in spite of this, we are unconvinced if this growth could extend, specially during troubled times. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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This article by Simply Wall St is general in nature. 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. Simply Wall St has no position in any stocks mentioned.
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