By Doreenn Leong

INVESTORS often look at return on equity (ROE) as a measure of how well a company uses investments to generate earnings growth. ROE is used mostly when comparing the performance of companies in the same industry.

The financial ratio measures a company’s profitability against the profit it has kept for the business including any capital injections. The “return” is the profit over the last 12 months. Generally, the higher the ROE, the more profit the company is making.

Essentially, the ability of the company’s management in generating income from the equity available is often gauged using the ROE. As a general rule, an ROE of 15%-20% is considered good.

Our Focus List ranks the companies with the best ROE based on their latest financial year end. Not surprisingly, multinational companies (MNCs) dominate the list as they are seen as generating steady cash flow with little need to raise capital.

The top ROE companies

Topping our list is Digi.Com Bhd with an impressive ROE of 228.88% in its financial year ended Dec 31, 2018 (FY18). The telecommunications (telco) operator also offered a dividend yield of 4.4% in FY18. 

Digi posted a net profit of RM1.54 bil in FY18 while its shareholders’ equity was RM673.19 mil. However, the telco operator saw its service revenue decline 3% in its nine months ended Sept 30, 2019 mainly due to 25.8% fall in non-internet prepaid revenue (on the back of falling legacy revenue) but largely cushioned by an 8.5% growth in postpaid and non-internet prepaid revenue. This means Digi saw improved mix of internet and digital revenue further from 55% to 63% of service revenue.

According to TA Securities, Digi’s strategic shift in revenue mix was supported by ongoing efforts to redefine its customer value proposition which has seen enhancements to network experience supplemented by value offerings like easy device ownership (PhoneFreedom 365), borderless and family plans, affordable internet passes, as well as personalised rewards and convenience via the MyDigi app to promote subscriber retention.

The research house points out that Digi has been taking a phased approach in expanding its fibre to the home (FTTH) services.

“They also see the expansion of FTTH services to help offload data and voice from the mobile network when customers are connected to WiFi, and this in turn would also help improve the network experience for all customers.

“And like peers, the group has been working on offering customers bundled propositions, namely with the bundling of postpaid and fixed broadband services.”

However, TA Securities made no changes to its earnings forecasts.

“We reiterate our sell recommendation on Digi with an unchanged target price of RM4.25 per share based on a WACC (weighted average cost of capital) of 7.5% and long-term growth rate of 1%. We opine that the stock is fairly valued at current levels, trading at an EV/Ebitda of 13.8 times CY20 Ebitda which is in line with the stock’s five-year mean.

In addition, the research house opines that Digi’s FY19/FY20/FY21 forward dividend yields of 4%/4.2%/4.3% are not attractive enough to warrant an entry considering the downside risk of continued challenges from its prepaid segment.

Carlsberg Brewery

Next on the list is Carlsberg Brewery Malaysia Bhd with an ROE of 158.43%. The brewer posted a net profit of RM286.76 mil in the financial year ended Dec 31, 2018 with shareholders’ equity of RM181 mil. The counter has a dividend yield of 6.5% in FY18.

Carlsberg’s nine months results ended Sept 30, 2019 core net profit grew by 6.4% yoy to RM222.6 mil due to higher organic sales across mainstream and premium brands from its operations in both Malaysia (+12.4% yoy) and Singapore (+6.7% yoy).

According to Affin Hwang Capital, this was partially offset by a dip in Ebit margins (-1.2 percentage points yoy) on the back of higher commercial-related spending as well as an increase in raw material costs. It points out that earnings contribution from its Lion Brewery associate remained robust (9M19: RM14.7 mil), despite higher beer duties (+12.5%) imposed in Sri Lanka from March, followed by bombing attacks which occurred in April. A higher dividend per share of 17 sen was announced for the quarter.

The research house maintains its earnings estimates and a hold call on the stock, with an unchanged target price of RM28.50.

Dutch Lady

Taking the third spot is Dutch Lady Milk Industries Bhd with an ROE of 122.75%. It registered a net profit of RM129.45 mil in the financial year ended Dec 31, 2018 while its shareholders’ equity was RM105.46 mil. For the third quarter ended Sept 30, 2019, it saw a decline in net profit to RM25.2 mil from RM34.21 mil a year ago despite posting higher revenue of RM278.31 mil versus RM257.05 mil previously.

Despite the lower net profit, the company declared an interim dividend of 50 sen per share amounting to RM32 mil in respect of the financial year ended Dec 31, 2019.

The company says the market remains volatile and is subject to various domestic and global uncertainties, foreign exchange rate and potential regulatory changes.

“However, the company continues to focus on growth increasing the consumption of milk among consumers,” Dutch Lady says.

Meanwhile, Astro Malaysia Holdings Bhd and British American Tobacco (Malaysia) Bhd took the fourth and fifth position respectively. Astro generated an ROE of 116.94% while BAT 111.11%.

Not the best benchmark

In reality, assessing the value of a company based on its ROE may not be the best method.

“ROE is looking at the specific historical base of a company, hence may not be the best benchmark across companies, especially public companies where the shares are publicly traded with market price that can be better measured with dividend yield, which is the ‘real return’ into the hands of investors,” says Baker Tilly Malaysia managing partner, audit & assurance Datuk Lock Peng Kuan.

“ROE differs from company to company as some companies, especially MNCs with steady cash flows, hardly see any capital call or transactions, as their international holding company is usually not pumping in more capital after the initial outlays – more so they are calling for dividends from these investments. Hence, the equity based of these companies might not differ much from year on year, and ROE could be deemed as a historical comparison based on their initial equity base,” he tells FocusM.

Lock adds that MNCs are well liked because many have fixed dividend policy where a big chunk of their profits is allocated for dividends.

“The MNCs don’t need to preserve capital for expansion and usually dividend yields are also high. At least the dividend yield is more reflective as it takes into account the current share price,” Lock adds.

Meanwhile, Etiqa Insurance and Takaful chief strategy officer Chris Eng says good ROEs on companies such as Dutch Lady and Digi are a potential indicator on positive long-term returns.

However, he adds that ROE should not be used as the sole indicator of the potential returns on companies.

“In cases where the regulatory environment mandates a higher level of capital, ROEs may be dampened not because the return is low but because the equity is high.

“In some cases, a high ROE may indicate a mature operating environment where growth opportunities are limited and thus companies have returned significant profits to shareholders in the form of dividends.

“So high ROEs are a good sign but should not be the sole characteristic when evaluating companies. ROE combined with CAGR (compound annual growth rate) and PER (price to earnings ratio) make for better combination,” he explains. 

Best ROE for FY18 – top five

1) Digi.Com Bhd

Founded in 1995, Digi.Com Bhd is a mobile connectivity and internet service provider, and is part of global telecommunications (telco) provider Telenor Group. Digi is also the first telco in Malaysia to launch and operate a fully digital cellular network. With 25 years of experience, Digi’s network now connects 11.3 million customers in populated areas nationwide with a footprint of 4G LTE.

Despite recording growth in all its segments, its net profit in the third quarter of financial year 2019 (3QFY19) slipped 9.3% to RM356.05 mil from RM392.54 mil in the preceding year corresponding quarter, after accounting for depreciation as well as finance cost of RM202 mil and RM26 mil respectively. Revenue also fell by 2.34% to RM1.56 bil from RM1.6 bil in the same period. 

Digi will continue to execute and deliver on its growth strategies especially in driving postpaid, business-to-business and prepaid internet growth in 4Q. 

“We will continue to sharpen our focus on structural operational efficiencies, investing in what matters most for our customers and continuously drive value creation for our stakeholders,” the telco said.

Digi’s largest shareholder is Telenor Asia Pte Ltd with a 49% stake while the management is spearheaded by its CEO Albern Murty.

2) Carlsberg Brewery Malaysia Bhd

Established in 1969, Carlsberg Brewery Malaysia Bhd is part of the Carlsberg Group, one of the leading international brewery groups in the world. Carlsberg is engaged in the manufacturing, marketing and distribution of alcoholic and non-alcoholic beverages with businesses in Malaysia and Singapore. The group also has a stake in in a Sri Lanka brewery, Lion Brewery (Ceylon) Plc. 

For its 3QFY19 ended Sept 30, the brewery’s net profit grew marginally by 6.1% to RM71.77 mil from RM67.66 mil in 3QFY18. The increase in net profit was driven by top-line growth and higher profits in both the Malaysia and Singapore

operations and the higher share of profit from its associate company, Lion Brewery. Meanwhile, revenue grew 10.04% to RM542.22 mil from RM492.77 mil in the same period, mainly attributed to higher sales in the current quarter and lower other operating expenses offset by higher marketing investments. 

The group is expected to sustain the current growth momentum for the rest of the year in anticipation of an early Chinese New Year in January next year.

Carlsberg is controlled by Carlsberg Breweries A/S with a 51% stake and is headed by its newly appointed managing director, Stefano Clini.

3) Dutch Lady Milk Industries Bhd

Dutch Lady Milk Industries Bhd is a subsidiary of FrieslandCampina, a Netherlands-based dairy cooperative. In 1963, Dutch Lady was incorporated in Malaysia to launch sweetened condensed milk into the market. Since then, the brand has evolved and has grown a wide range of milk as well as dairy products suitable for all ages. Dutch Lady is the first milk company in Malaysia to be listed on Bursa Malaysia.

For its 3QFY19 ended Sept 30, the dairy company saw its net profit dipped 26.33% to RM25.2 mil from RM34.21 mil in the same period a year ago. The company attributed the decrease in net profit to category product mix changes, higher raw material prices, negative exchange rates, investment in advertising and promotional spend, as well as the Sales and Service Tax on local and imported services. However, revenue grew 7.49% to RM276.31 mil from RM257.05 mil in 3QFY18. 

“The market remains volatile and is subject to various domestic and global uncertainties, foreign exchange rate and potential regulatory changes,” said Dutch Lady on its prospects. 

However, the company will continue to focus on growth increasing the consumption of milk among consumers moving forward. 

Dutch Lady is controlled by FrieslandCampina through FrieslandCampina DLMI Malaysia Holding BV with a 50.97% stake. The company is led by its managing director, Tarang Gupta.

4) Astro Malaysia Holdings Bhd

In 1996, Astro Malaysia Holdings Bhd was incorporated and launched its own satellite subscription service. Astro is the country’s leading content and consumer company in the TV, over-the-top (OTT), radio, digital and commerce space.

For its 3QFY20 ended Oct 30, Astro’s net profit rose 10.48% to RM169.72 mil from RM153.62 in 3QFY19 mainly due to reduced content costs and lower impairment of receivables.

However, its revenue dipped 12.18% to RM1.22 bil from RM1.38 bil in the same period, dragged by a drop in subscription revenue, offset by an increase in advertising revenue and merchandise sales.

“Our focus is to strengthen its core Pay TV and NJOI businesses by redefining customer value propositions, elevating customer service, refreshing and aggregating the best content,” Astro said on its prospect for the current financial year. 

The company added that it will leverage on its customer base to build new revenue adjacencies in commerce, broadband, digital and OTT while continuing its disciplined cost optimisation efforts. 

Telco tycoon Ananda Krishnan controls Astro with a 40.91% stake held through his private investment vehicle Usaha Tegas Sdn Bhd. Meanwhile, Henry Tan leads the management as its CEO. 

In FY18, Astro’s return on equity stood at 116.94% and is at the number four spot in our list.

5) British American Tobacco (Malaysia) Bhd

British American Tobacco (Malaysia) Bhd (BAT) was established in Malaysia in 1912 and is the largest and leading tobacco company in the country with approximately 56.3% of market share in the legal market.

For its 3QFY19, the tobacco company saw its net profit shrank 43% to RM83.13 mil from RM145.81 mil in the previous year’s corresponding quarter. The decline in net profit was attributed to lower cigarette volume as a result of legal market contraction and the absence of one-off factors reported in the same period last year such as the benefit from the Goods and Services Tax removal and the prior year’s tax stamps refunds. Quarterly revenue also reduced by 20.55% to RM584.34 mil from RM735.53 mil in 3QFY18. 

BAT says it will remain committed to adopting a multicategory approach with investment into new category segments such as tobacco-heated products, where Malaysia is the first market in Southeast Asia to launch “Glo”. It will also continue to rationalise operating costs and work closely with the authorities on enhancing enforcement and setting up a comprehensive and sustainable total regulatory and fiscal framework.

BAT is controlled by London-based British American Tobacco Plc with a 50% stake. Hendrik Stoel is the managing director of BAT. – Jan 3, 2020