Stock Analysis

Declining Stock and Decent Financials: Is The Market Wrong About Galp Energia, SGPS, S.A. (ELI:GALP)?

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ENXTLS:GALP
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With its stock down 12% over the past month, it is easy to disregard Galp Energia SGPS (ELI:GALP). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Galp Energia SGPS' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Galp Energia SGPS

How Do You 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 Galp Energia SGPS is:

15% = €710m ÷ €4.9b (Based on the trailing twelve months to June 2022).

The 'return' is the profit over the last twelve months. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.15.

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. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Galp Energia SGPS' Earnings Growth And 15% ROE

To begin with, Galp Energia SGPS seems to have a respectable ROE. Even when compared to the industry average of 17% the company's ROE looks quite decent. For this reason, Galp Energia SGPS' five year net income decline of 43% raises the question as to why the decent ROE didn't translate into growth. 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.

That being said, we compared Galp Energia SGPS' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 10% in the same period.

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ENXTLS:GALP Past Earnings Growth October 3rd 2022

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is Galp Energia SGPS fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Galp Energia SGPS Using Its Retained Earnings Effectively?

Galp Energia SGPS has a high three-year median payout ratio of 87% (that is, it is retaining 13% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. Our risks dashboard should have the 3 risks we have identified for Galp Energia SGPS.

Additionally, Galp Energia SGPS has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 39% over the next three years. The fact that the company's ROE is expected to rise to 23% over the same period is explained by the drop in the payout ratio.

Summary

Overall, we feel that Galp Energia SGPS certainly does have some positive factors to consider. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. That being so, the latest industry analyst forecasts show that analysts are forecasting a slight improvement in the company's future earnings growth. The company's existing shareholders might have some respite after all. 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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