The most popular ratios used by many investors and market participants are the price to earnings multiple and the dividend yield. These were tackled in detail in two of my recent articles including the annual dividend league table which is updated and published in May each year.

However, the return on equity (ROE) is another important financial indicator since it measures the profit achieved by a company from the amount of money invested by shareholders. It is calculated by dividing profits by the amount of average shareholders’ funds. Essentially, it shows whether management is growing the company’s value at an adequate rate of return.

In May 2014, I had published the ROE league table following the conclusion of the annual reporting season which comes to an end on April 30 for the numerous companies having a December year-end. Similarly to the dividend league table, updating the ROE league table to monitor the changes from one year to the next as well as the trends across sectors and individual companies over a number of years, should prove interesting.

The ROE league table depicts those companies which achieved a double-digit return on equity during their last financial year. The ROEs are calculated using after-tax profits.

Coincidentally, similar to last year, only eight companies have a double-digit ROE among the 22 listed on the Malta Stock Exchange.

Last year’s top position was occupied by Crimsonwing plc. However, this company is not monitored any longer following the delisting of the company’s shares from the Malta Stock Exchange in May 2015 after it was acquired by KPMG Investments Malta Ltd.

The top rank for 2015 goes to Malta International Airport plc which placed second last year. MIA improved its ROE yet again to 23.9 per cent following another record financial year with after-tax profits climbing by 15.4 per cent to €16.8 million on the back of a 6.4 per cent increase in passenger movements as well as an improved contribution from the ‘retail and property’ segment arising from the SkyParks Business Centre, the concessionaires within the air terminal, the car park and the VIP lounge. It is worth mentioning that MIA has been among the most consistent positive performers as it registered double-digits returns on equity for the past 11 years.

Medserv plc ranks in second place and is the company that registered the largest improvement in ROE as this increased to 22.7 per cent from only 5 per cent in 2013. In last year’s article I had highlighted the possibility of Medserv reporting a higher ROE but the extent of the improvement was far superior since the Medserv Group registered profits after tax of €1.9 million in 2014, a significant 37 per cent above the projected €1.6 million. Shareholders would also be interested to note that the latest Medserv financial forecasts, which the company is obliged to publish on an annual basis as part of its ongoing obligations of its bond issue, reveal that this is likely to increase further in 2015 as the directors anticipate profits to rise by a further 33 per cent to €2.6 million during the current financial year.

Malita Investments plc is the only property company that features in the ROE league table. Property companies normally have low ROEs due to the nature of their business which is very capital intensive. However, in the case of Malita, the income statement takes into account movements in the fair value of investment property which simply reflects the changes in the present value attributable to the cash flows receivable by the company in relation to the MIA and VCP sites in line with the changes in Malta Government Stock yields which are used as a benchmark to discount the future cash flows receivable.

Due to the significant decline in yields seen during 2014, Malita recognised €15.7 million in fair value gains which left a significant positive impact on the profitability during the year. This may be reversed in subsequent years should yields begin to rebound from the very low levels which could imply that Malita would drop several positions in the ROE league table.

In the IT sector, 6PM Holdings plc and RS2 Software plc again feature among the eight companies that registered double-digit ROEs. Minimal movements were registered over last year and while the ROE of 6PM improved from 14.1 per cent to 14.5 per cent, that of RS2 dropped from 14.4 per cent to 12.5 per cent as the profit in 2014 declined marginally to €2.88 million compared to €2.93 million in 2013.

Management of publicly-traded companies should therefore guide investors on their ROE targets

Although they both operate in the IT sector, the business models and financial structures of these two companies are very different and the financial performance of RS2 is very much dependent on the timing of licence sales and the different accounting treatment adopted for perpetual licences as opposed to term licences. Perpetual licences are recognised immediately upon confirmation and, in 2013, RS2 recognised €5.5 million in licence income related to the agreement with Barclays Bank for the Bankworks software while the balance will be recognised upon other contractual milestones being achieved in the future.

On the other hand, revenue from licence sales declined by 46 per cent in 2014 notwithstanding the fact that RS2 signed its largest ever licence agreement during the year. However, the €12 million contract signed last year with one of the largest global payment processing companies is a term licence and is being split over the finite term of the licence with the 2014 financial statements only reflecting around €2.2 million of this licence.

Meanwhile, 6PM is currently in the process of raising €13 million in debt funding via a bond issue through its shareholders to enable it to conduct an acquisition of a company in the UK and to enhance its software products. Should the company achieve its financial projections over the next two years as disclosed in the prospectus, the ROE is expected to improve significantly from current levels possibly leading to a higher ranking in the league table.

The ROEs of the banks continued to decline with Bank of Valletta plc dropping from 4th position to 7th place as the return dropped to 11.4 per cent during the year ended September 30, 2014 from 14.4 per cent in the previous financial year.

Meanwhile, HSBC Bank Malta plc does not feature any longer in the ROE league table as the return declined to 7.7 per cent from 14.3 per cent in 2013.

BoV’s after-tax profit during the 2013/14 financial year had declined by 12.8 per cent to €68.9 million but the ROE could improve this year following the double-digit profit growth during the first six months to March 31, 2015. However, the regulatory requirement to maintain higher levels of capital across the banking industry could continue to limit the growth in shareholder returns going forward.

On the other hand, Go plc improved its ranking to 5th position from 7th place last year with an ROE of 13.7 per cent following another positive year for the group. The property spin-off expected to take place by the end of this year is expected to improve the overall ROE assuming that the profitability of the core operations is not negatively impacted. In fact, based on the 2014 pro-forma accounts of Go plc presented in the Circular to Shareholders published in connection with the extraordinary general meeting that was held yesterday, the 2014 ROE would have been around 16.5 per cent as Go’s equity base is expected to contract by 29.4 per cent or €32.3 million whilst its net income will only be adjusted lower by 12.3 per cent or €1.8 million.

Likewise, Maltapost now features in the league table following a significant improvement in profits during the last financial year to September 30, 2014 on the back of the continued growth in the e-commerce business as well as the revision of certain tariffs as from January 2014. The ROE of the postal operator should improve further during the current financial year following the strong growth in profits during the first half of the year although the profit increase was largely attributable to one-off write-backs of previously accrued expenses. Moreover, should Maltapost begin to distribute cash dividends only, thereby limiting any further increases in the capital base, any further profitability growth would lead to a more meaningful increase in the ROE, thereby helping the equity move up in the league table. In fact, the Company’s ROE dropped from 21.6 per cent in the financial year ended September 30, 2008 (coinciding with its listing on the Malta Stock Exchange) to 10.6 per cent as at September 30, 2008 solely on the back of the 102.6 per cent increase in the company’s equity base whilst net profit remain unchanged at the €1.8 million level.

Although it is useful to monitor changes in the return on equity for various companies and industries from one year to the next and analysing trends over a longer time period, it is more important for shareholders to obtain guidance on future trends. Management of publicly-traded companies should therefore guide investors on their ROE targets going forward and any initiatives being undertaken to grow shareholder returns.

    ROE Year end
1 Malta International Airport plc 23.9% December 2014
2 Medserv plc 22.7% December 2014
3 Malita Investments plc 15.5% December 2014
4 6PM Holdings plc 14.5% December 2014
5 GO plc 13.7% December 2014
6 RS2 Software plc 12.5% December 2014
7 Bank of Valletta plc 11.6% September 2014
8 MaltaPost plc 10.6% September 2014

Rizzo, Farrugia & Co. (Stockbrokers) Ltd (RFC) is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the company/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. RFC, its directors, the author of this report, other employees or RFC on behalf of its clients, have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent, and may also have other business relationships with the company/s. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither RFC, nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.

© 2015 Rizzo, Farrugia & Co. (Stockbrokers) Ltd. All rights reserved.

Edward Rizzo is a director at Rizzo, Farrugia & Co. (Stockbrokers) Ltd.

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