Hannon Armstrong Sustainable Infrastructure Capital Inc (HASI): Can It Deliver A Superior ROE To The Industry?

Hannon Armstrong Sustainable Infrastructure Capital Inc (NYSE:HASI) generated a below-average return on equity of 5.57% in the past 12 months, while its industry returned 8.92%. HASI's results could indicate a relatively inefficient operation to its peers, and while this may be the case, it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components could change your view on HASI’s performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of HASI's returns. Let me show you what I mean by this. View our latest analysis for Hannon Armstrong Sustainable Infrastructure Capital

Breaking down ROE — the mother of all ratios

Return on Equity (ROE) is a measure of HASI’s profit relative to its shareholders’ equity. For example, if HASI invests $1 in the form of equity, it will generate $0.06 in earnings from this. If investors diversify their portfolio by industry, they may want to maximise their return in the Mortgage REITs sector by investing in the highest returning stock. However, this can be deceiving as each company has varying costs of equity and debt levels, which could exaggeratedly push up ROE at the same time as accumulating high interest expense.

ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for HASI, which is 8.49%. This means HASI’s returns actually do not cover its own cost of equity, with a discrepancy of -2.93%. This isn’t sustainable as it implies, very simply, that the company pays more for its capital than what it generates in return. ROE can be broken down into three different ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:

Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient HASI is with its cost management. The other component, asset turnover, illustrates how much revenue HASI can make from its asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable HASI’s capital structure is. We can determine if HASI’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 HASI’s debt-to-equity ratio. The ratio currently stands at a high 213.58%, meaning HASI may have taken on a disproportionate level of debt which is driving its return. The company’s ability to produce profit growth may hinge on its big debt burden.

ROE - It’s not just another ratio

ROE is called the mother of all ratios for a reason. It helps gauge a company’s efficiency by looking at both its income statement and balance sheet. HASI’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of HASI’s return with a possible increase should the company decide to increase its debt levels. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.

For Hannon Armstrong Sustainable Infrastructure Capital, there are three important factors 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. Valuation: What is HASI worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether HASI is currently mispriced by the market.

3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of HASI? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!

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Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article 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.