Does Meridian Energy Limited's (NZSE:MEL) Weak Fundamentals Mean That The Market Could Correct Its Share Price?
Most readers would already be aware that Meridian Energy's (NZSE:MEL) stock increased significantly by 18% over the past three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Particularly, we will be paying attention to Meridian Energy's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for Meridian Energy
How Do You Calculate Return On Equity?
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 Meridian Energy is:
1.6% = NZ$95m ÷ NZ$6.0b (Based on the trailing twelve months to June 2023).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each NZ$1 of shareholders' capital it has, the company made NZ$0.02 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
Meridian Energy's Earnings Growth And 1.6% ROE
It is quite clear that Meridian Energy's ROE is rather low. Not just that, even compared to the industry average of 9.4%, the company's ROE is entirely unremarkable. However, the moderate 7.3% net income growth seen by Meridian Energy over the past five years is definitely a positive. Therefore, the growth in earnings could probably have been caused by other variables. Such as - high earnings retention or an efficient management in place.
We then compared Meridian Energy's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 13% in the same 5-year period, which is a bit concerning.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is MEL fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Meridian Energy Efficiently Re-investing Its Profits?
Meridian Energy has a very high three-year median payout ratio of 133% suggesting that the company's shareholders are getting paid from more than just the company's earnings. In spite of this, the company was able to grow its earnings respectably, as we saw above. That being said, the high payout ratio could be worth keeping an eye on in case the company is unable to keep up its current growth momentum. Our risks dashboard should have the 2 risks we have identified for Meridian Energy.
Moreover, Meridian Energy is determined to keep sharing its profits with shareholders which we infer from its long history of nine years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 117%. Regardless, the future ROE for Meridian Energy is predicted to rise to 9.0% despite there being not much change expected in its payout ratio.
Conclusion
On the whole, Meridian Energy's performance is quite a big let-down. While the company has posted decent earnings growth, the company is retaining little to no profits and is reinvesting those profits at a low rate of return. This makes us doubtful if that growth could continue, especially if by any chance the business is faced with any sort of risk. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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This article by Simply Wall St 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. Simply Wall St has no position in any stocks mentioned.
