Declining Stock and Decent Financials: Is The Market Wrong About Spring Airlines Co., Ltd. (SHSE:601021)?

It is hard to get excited after looking at Spring Airlines' (SHSE:601021) recent performance, when its stock has declined 15% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Spring Airlines' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Spring Airlines

How Is ROE Calculated?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Spring Airlines is:

17% = CN¥2.8b ÷ CN¥16b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every CN¥1 worth of equity, the company was able to earn CN¥0.17 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Spring Airlines' Earnings Growth And 17% ROE

To start with, Spring Airlines' ROE looks acceptable. Even when compared to the industry average of 18% the company's ROE looks quite decent. However, while Spring Airlines has a pretty respectable ROE, its five year net income decline rate was 4.4% . Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

So, as a next step, we compared Spring Airlines' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 26% over the last few years.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is 601021 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Spring Airlines Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 25% (that is, a retention ratio of 75%), the fact that Spring Airlines' earnings have shrunk is quite puzzling. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, Spring Airlines has been paying dividends over a period of nine years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 26%. As a result, Spring Airlines' ROE is not expected to change by much either, which we inferred from the analyst estimate of 18% for future ROE.

Summary

In total, it does look like Spring Airlines has some positive aspects to its business. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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. 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. Simply Wall St has no position in any stocks mentioned.