10 April 2013

Example of ROE - Lian Beng

In last article, I emphasized on the importance of ROE for us to judge on how good the company management in improving shareholder value. Let me use Lian Beng as an example to demonstrate.

ROE (Return on Equity) is divided mainly into three parts:
  1. Net Profit Margin - How much profit the company can earn from the revenue, in another words, what is the bargaining power against its suppliers and customers as well as whether it is in fierce competition among the peers. 
  2. Asset Turnover - How much revenue the company generate from existing assets, in another words, how efficient the company is to generate more revenue from limited assets 
  3. Equity Multiplier - How good the company in managing its corporate finance
Below is the breakdown of Lian Beng's ROE for financial year 2006 to financial year 2012 :


From the above image, you can notice that Lian Beng is leveraging on debt to generate the revenue. In normal circumstance, it is cheaper to employ debt instead of equity to expand the business. However, as Lian Beng is in Construction industry, it can be categorized as cyclical stock, or in layman term, the company revenue varies all the time. It can be very good in certain years and not performing well after the peak period. Nonetheless, you can see that Lian Beng's Equity Mutiplier remains at 2.5x to 3.0x.

The main generator to push ROE higher is the Net Profit Margin component. Lian Beng's property division and Concrete division were growing, especially Concrete division which grew significantly and seek for listing in Taiwan stock market.

Ok, let us look at the growth of the Shareholder Value, or in short the Equity position in Balance Sheet.


As you can see from the table above, ROE was getting higher after Lian Beng raised the right issue in financial year 2008. This is due to the fact that it was getting more contracts from government and private developers after Singapore government announced the plan to build 2 resorts in Marina Bay and Sentosa respectively. As of current date, the construction project GDV is around S$1.1B, which can last until financial year 2017.

Shareholder Value rose from $58M as at FY2007 to $242M as at FY2012. Even if we exclude the right issue on FY2008, the Equity Growth was near to the G rate. G = ROE * (1 - Dividend Payout Ratio). If the shareholder value can grow at 10% every year, I would consider the company is in very healthy position in doing its business. Nonetheless, I prefer the company can venture more into property development sector, as the profit margin is higher there. To Lian Beng, it has grown to second stage as it can now take in more projects as the equity base is larger compared to 5 years ago. More importantly, we can see a grow in investment holdings in Non-Current Assets, which derived from joint-venture with other property developers.

Summary: It does not really mean that high ROE is good, or it not good to have high Equity Multiplier. We should look at how efficient the management in managing its cash flow so that it will not face the cash flow shortage issue. 

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