TransAlta Renewables Inc.'s (TSE:RNW) On An Uptrend But Financial Prospects Look Pretty Weak: Is The Stock Overpriced?
TransAlta Renewables (TSE:RNW) has had a great run on the share market with its stock up by a significant 10% over the last three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Particularly, we will be paying attention to TransAlta Renewables' 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.
Check out our latest analysis for TransAlta Renewables
How Is ROE Calculated?
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 TransAlta Renewables is:
4.5% = CA$77m ÷ CA$1.7b (Based on the trailing twelve months to June 2023).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.05 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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
TransAlta Renewables' Earnings Growth And 4.5% ROE
At first glance, TransAlta Renewables' ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 9.1%. Given the circumstances, the significant decline in net income by 17% seen by TransAlta Renewables over the last five years is not surprising. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.
That being said, we compared TransAlta Renewables' 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 17% in the same 5-year period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is TransAlta Renewables fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is TransAlta Renewables Making Efficient Use Of Its Profits?
TransAlta Renewables' high three-year median payout ratio of 237% suggests that the company is depleting its resources to keep up its dividend payments, and this shows in its shrinking earnings. Paying a dividend higher than reported profits is not a sustainable move. You can see the 2 risks we have identified for TransAlta Renewables by visiting our risks dashboard for free on our platform here.
In addition, TransAlta Renewables 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 drop to 143% over the next three years. As a result, the expected drop in TransAlta Renewables' payout ratio explains the anticipated rise in the company's future ROE to 12%, over the same period.
Summary
On the whole, TransAlta Renewables' performance is quite a big let-down. The low ROE, combined with the fact that the company is paying out almost if not all, of its profits as dividends, has resulted in the lack or absence of growth in its earnings. 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. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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.
