In last week’s article I shared my view that, apart from dividend returns, investors should also take into account the return on equity (ROE) when considering which companies to invest in.

Following the end of the 2015 annual reporting season, the updated ROE league table highlights those companies which are generating the highest returns and also enables investors to compare the changes from one year to the next.

Today’s article reviews the 10 companies that generated double-digit ROE’s during their 2015 financial year.

By far, the company that generated the highest ROE in 2015 was Medserv plc with an impressive return of 40.5 per cent. The ROE of Medserv increased significantly from 22.7 per cent in 2014 as the company’s profits after tax surged to €4.12 million in 2015 from €1.94 million in 2014. It is also worth highlighting that Medserv’s ROE during the 2013 financial year was only five per cent. The significant upturn in the ROE over the past two years is testament to the strong improvement in profits as a number of contracts offshore Libya commenced and the company also benefited from the contribution of the new Cypriot base. By the end of this month, Medserv will be publishing its 2016 financial projections and investors will have an indication whether the directors are expecting this return to be sustainable or otherwise during the current financial year. The projections will also include the initial contribution from METS following the acquisition of this company in February 2016 and investors will gain an early insight as to analyse whether this strategic move will immediately begin to generate positive returns for shareholders.

GO plc ranks in second position in the 2016 ROE league table with a return of 27 per cent. The ROE improved substantially from only 7.8 per cent in 2015 on account of two factors (i) the improved profitability in 2015 (an €6 million uplift in operational results, the fair value uplift of €7 million related to the option which GO held in relation to its investment in the Cypriot telecoms company Cablenet as well as the €6.6 million impairment on the investment in Forthnet accounted for in the restated 2014 results) and (ii) the reduction in shareholders’ funds by 11 per cent to €92.1 million following the spin-off during the year of Malta Properties Company plc. Although the immediate focus for GO shareholders in the coming weeks will be news regarding the identity of the selected preferred bidder for the company and the price which will be offered to all shareholders, the interim financial statements as at June 30, 2016, (generally published by early August) should begin to show the contribution of the Cypriot company after GO increased its equity stake to 51 per cent in January 2016.

Malta International Airport plc has been one of the most consistent performers in recent years. Although the ROE of the airport operator improved from 24 per cent to 25.5 per cent between 2014 and 2015, the company dropped to third position from the top ranking position last year. 2016 should be another very positive year for MIA as passenger traffic is expected to reach yet another record following the 12 per cent increase in the first four months of the year coupled with the additional seat capacity in both the summer schedule and also the winter months.

The two companies in the IT sector both rank among those that generated double-digit returns. RS2 Software plc is in fourth position with an ROE of 18.8 per cent during the 2015 financial year, up from 12.5 per cent in 2014 following the 70 per cent increase in profits despite the impairment on receivables of €1.2 million.

One would need to understand the potential future prospects of the company or sector in question and additional information in this respect is essential from local companies to assist investors

Meanwhile, the ROE of 6pm Holdings plc only improved from 14.5 per cent to 15.8 per cent although the profits more than doubled to £1.69 million from £0.81 million in 2014 largely reflecting the consolidation of Blithe Computer Systems Ltd in the UK as from July 2015.

The increased profitability was counter balanced by the fact that the company’s equity base improved by £11.5 million to £15.8 million reflecting the £9 million (net of deferred tax) revaluation of the group’s proprietary software solutions.

In the banking sector, only Bank of Valletta ranks in the top 10 positions with an ROE of 12.4 per cent during its 2014/2015 financial year. Recently, BOV issued its interim financial statements for the six months ended March 31, 2016 with profits after tax rising by 11 per cent to €44.6 million translating into an annualised ROE of 13.2 per cent.

However, the bank has continued to indicate that they will need to increase their Tier 1 capital in the near term (possibly through a mix of higher profit retention and additional equity through a rights issue or a placement of shares to new investors) and this could negatively impact the ROE going forward.

On the other hand, the ROE of HSBC Bank Malta plc declined from 7.8 per cent during their 2014 financial year to 6.5 per cent as the bank’s performance was impacted by the cost of the voluntary early retirement scheme of €14.7 million.

Lombard Bank Malta plc saw its ROE improve slightly from 4.2 per cent in 2014 to 5.1 per cent mainly on lower impairment provisions.

Tracking the ROEs and other financial indicators of companies over a number of years provides a good overview of trends across a specific company or sector. In this respect, it is worth highlighting the rapid decline in returns across the banking sector. The ROE of HSBC Malta was above 20 per cent in 2008 but dropped to below 10 per cent in 2014 and 2015. Likewise, Lombard Bank Malta saw its ROE drop from 15 per cent in 2008 to below 10 per cent in each of the last five financial years.

On the other hand, BOV’s ROE was more volatile due to the impact of fair value adjustments in their income statement. However, BOV continued to generate double-digit ROE’s during each of the last four financial years.

Midi plc also registered a double-digit ROE in 2015 and ranks seventh in the league table with a return of 15 per cent. This property development company benefited from the recognition of property sales revenue amounting to €38.8 million in 2015 as the company concluded the final deeds on the large majority of apartments from the Q1 residential block. However, this return is unlikely to be repeated in 2016 on a lower amount of final deeds of sale during the current financial year as the Q2 apartments (60 in total) are being sold on plan with final deeds expected during the first half of 2018 upon delivery of the finished apartments.

The three property rental companies have differing ROEs due to their unique characteristics. Malita Investments plc ranks among the top 10 companies on the MSE as the company’s performance was again very positively impacted by the fair value gains amounting to €11.6 million which helped the company’s profit amount to €16.6 million. On the other hand, the other two companies (Tigné Mall plc and Plaza Centres plc) do not hold investment property and therefore their income statement is not impacted by any changes in value to investment property. Instead, property revaluations are reflected only in the balance sheet. In fact, the ROEs of these two companies are similar. The ROE of Tigné Mall improved from 4.1 per cent in 2013 to 5.2 per cent in 2015 and Plaza’s edged up to 4.2 per cent from 3.9 per cent in 2013. The ROE of Tigné Mall is higher than that of Plaza due to its relatively higher leverage which offsets the better operational performance of Plaza.

Although the two ratios I discussed in my latest articles are very important indicators, they are definitely not the only ones which need to be take into consideration when analysing companies. Additionally, it is important to highlight that financial ratios are based on historical figures. More importantly, one would need to understand the potential future prospects of the company or sector in question and additional information in this respect is essential from local companies to assist investors accordingly. Furthermore, investors should also be cognisant of the various risks related to a specific company and the industry in which it operates, in order to assess whether this is in line with the investor’s own risk profile before taking an investment decision.

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.

© 2016 Rizzo, Farrugia & Co. (Stockbrokers) Ltd. All rights reserved.

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

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