United Breweries Limited (NSE:UBL) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

United Breweries (NSE:UBL) has had a great run on the share market with its stock up by a significant 13% over the last three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on United Breweries' ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for United Breweries

How To Calculate Return On Equity?

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 United Breweries is:

1.7% = ₹581m ÷ ₹34b (Based on the trailing twelve months to December 2020).

The 'return' is the yearly profit. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.02 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.

United Breweries' Earnings Growth And 1.7% ROE

It is hard to argue that United Breweries' ROE is much good in and of itself. Even when compared to the industry average of 8.8%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 8.3% seen by United Breweries was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared United Breweries' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 14% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if United Breweries is trading on a high P/E or a low P/E, relative to its industry.

Is United Breweries Efficiently Re-investing Its Profits?

When we piece together United Breweries' low three-year median payout ratio of 13% (where it is retaining 87% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. 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, United Breweries has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 21% over the next three years. Still, forecasts suggest that United Breweries' future ROE will rise to 16% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Conclusion

Overall, we have mixed feelings about United Breweries. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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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