Z Energy Limited (NZSE:ZEL) Has Fared Decently But Fundamentals Look Uncertain: What Lies Ahead For The Stock?

By
Simply Wall St
Published
July 28, 2021
NZSE:ZEL
Source: Shutterstock

Z Energy's (NZSE:ZEL) stock is up by 9.3% over the past three months. However, the company's financials look a bit inconsistent and market outcomes are ultimately driven by long-term fundamentals, meaning that the stock could head in either direction. Particularly, we will be paying attention to Z Energy's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Z Energy

How Is ROE Calculated?

ROE 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 Z Energy is:

5.6% = NZ$57m ÷ NZ$1.0b (Based on the trailing twelve months to March 2021).

The 'return' is the income the business earned over the last year. So, this means that for every NZ$1 of its shareholder's investments, the company generates a profit of NZ$0.06.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

A Side By Side comparison of Z Energy's Earnings Growth And 5.6% ROE

When you first look at it, Z Energy's 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 11% either. Therefore, it might not be wrong to say that the five year net income decline of 30% seen by Z Energy was probably the result of it having a lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

So, as a next step, we compared Z Energy's 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 7.6% in the same period.

past-earnings-growth
NZSE:ZEL Past Earnings Growth July 28th 2021

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Z Energy's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Z Energy Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 45% (that is, a retention ratio of 55%), the fact that Z Energy's earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Z Energy has paid dividends over a period of eight years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 110% over the next three years. However, Z Energy's future ROE is expected to rise to 14% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.

Summary

In total, we're a bit ambivalent about Z Energy's performance. 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. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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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