Why Public Joint-Stock Company Ukrtelecom (FRA:UK1) May Not Be As Efficient As Its Industry

With an ROE of 9.90%, Public Joint-Stock Company Ukrtelecom (DB:UK1) returned in-line to its own industry which delivered 11.83% over the past year. But what is more interesting is whether UK1 can sustain or improve on this level of return. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of UK1’s returns. Check out our latest analysis for Ukrtelecom

Breaking down ROE — the mother of all ratios

Return on Equity (ROE) weighs Ukrtelecom’s profit against the level of its shareholders’ equity. An ROE of 9.90% implies €0.1 returned on every €1 invested, so the higher the return, the better. If investors diversify their portfolio by industry, they may want to maximise their return in the Integrated Telecommunication Services sector by investing in 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 measured against cost of equity in order to determine the efficiency of Ukrtelecom’s equity capital deployed. Its cost of equity is 9.35%. Ukrtelecom’s ROE exceeds its cost by 0.55%, which is a big tick. Some of its peers with higher ROE may face a cost which exceeds returns, which is unsustainable and far less desirable than Ukrtelecom’s case of positive discrepancy. ROE can be split up into three useful 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

DB:UK1 Last Perf Jun 4th 18
DB:UK1 Last Perf Jun 4th 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 Ukrtelecom can make from its asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. We can determine if Ukrtelecom’s ROE is inflated by borrowing high levels of debt. Generally, a balanced capital structure means its returns will be sustainable over the long run. We can examine this by looking at Ukrtelecom’s debt-to-equity ratio. The most recent ratio is 25.51%, which is sensible and indicates Ukrtelecom has not taken on too much leverage. Thus, we can conclude its below-average ROE may be a result of low debt, and Ukrtelecom still has room to increase leverage and grow future returns.

DB:UK1 Historical Debt Jun 4th 18
DB:UK1 Historical Debt Jun 4th 18

Next Steps:

ROE is one of many ratios which meaningfully dissects financial statements, which illustrates the quality of a company. While Ukrtelecom exhibits a weak ROE against its peers, its returns are sufficient enough to cover its cost of equity. Also, 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. Although ROE can be a useful metric, it is only a small part of diligent research.

For Ukrtelecom, I’ve compiled three relevant aspects you should look at:

  1. 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.
  2. Future Earnings: How does Ukrtelecom’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
  3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Ukrtelecom? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!