WEC Energy Group Inc (NYSE: WEC) delivered an above average 13.1% ROE over the past year, compared to the 8.4% return generated by the Utilities sector. WEC Energy’s results may indicate management is running an efficient business relative to its peers, which may very well be the case, but it is important to understand what ROE is made up of and how it should be interpreted. Knowing these components may change your view on WEC Energy’s performance and future prospects. I show you exactly what I mean in my DuPont analysis below.
How To Calculate WEC Energy’s ROE
Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested. Return on Equity or ROE is generally calculated using the following formula:
ROE = Net Income To Common / Average Total Common Equity
ROE is a helpful metric that illustrates how effective the company is at turning the cash put into the business into gains or returns for investors. However, it is important to note that ROE can be “manufactured” by management with the use of leverage or debt.
The return on equity achieved by WEC Energy over the last few years is shown below.
source: finbox.io data explorer – ROE
It appears that the return on equity of WEC Energy has generally been increasing over the last few years. ROE increased from 9.8% to 10.7% in fiscal year 2016, increased to 13.1% in 2017 and the LTM period is also its latest fiscal year. So what’s causing the general improvement?
Understanding WEC Energy’s Improving Return On Equity
The DuPont analysis is another way to calculate a company’s ROE using the following three metrics:
Return on Equity = Net Profit Margin * Asset Turnover * Equity Multiplier
Analyzing changes in these three items over time allows investors to figure out if operating efficiency, asset use efficiency or the use of leverage is what’s causing changes in ROE. Strong companies should have ROE that is increasing because its net profit margin and/or asset turnover is increasing. On the other hand, a company may not be as strong as investors would otherwise think if ROE is increasing from the use of leverage or debt.
So what exactly is causing WEC Energy’s improving returns?
Net Profit Margin Trends
It appears that the net profit margin of WEC Energy has generally been increasing over the last few years. Margins increased from 10.8% to 12.6% in fiscal year 2016, increased to 15.7% in 2017 and the LTM period is also its latest fiscal year.
Therefore, the company’s increasing margins help explain, at least partially, why ROE is also increasing. Now let’s take a look at WEC Energy’s efficiency performance to see if that is also boosting ROE.
Asset Turnover Trends
Unfortunately for shareholders, WEC Energy’s asset turnover has decreased each year since 2015. Turnover decreased from 0.27x to 0.25x in fiscal year 2016, decreased to 0.25x in 2017 and the LTM period is also its latest fiscal year.
source: data explorer – asset turnover
Therefore, the company’s improving ROE is not as a result of its asset turnover performance which has been steadily declining.
Finally, the DuPont constituents that make up WEC Energy’s ROE are shown in the table below. Note that the table also compares WEC Energy to a peer group that includes Eversource Energy(NYSE: ES), CMS Energy Corporation (NYSE: CMS), Public Service Enterprise Group Incorporated (NYSE: PEG) and Ameren Corporation (NYSE: AEE).
source: finbox.io’s DuPont model
In conclusion, the DuPont analysis has helped us better understand that WEC Energy’s general improvement in return on equity is the result of an improving net profit margin, a declining asset turnover ratio and declining leverage. Therefore when looking at the core operations of the business, WEC Energy shareholders should not be too excited due to the company’s general improvement in profitability along with deteriorating operational efficiency and declining leverage.
The DuPont approach is a helpful tool when analyzing how well management is utilizing shareholder capital. But before making an investment decision, I recommend you continue to research WEC Energy to get a more comprehensive view of the company by looking at:
Valuation Metrics: what is WEC Energy’s EBITDA less CapEx multiple and how does it compare to its peers? This is a helpful multiple to analyze when comparing capital intensive businesses. View the company’s EBITDA less CapEx multiple here.
Risk Metrics: what is WEC Energy’s asset efficiency? This ratio measures the amount of cash flow that a company generates from its assets. View the company’s asset efficiency here.
Efficiency Metrics: is management becoming more or less efficient in creating value for the firm? Find out by analyzing the company’s return on invested capital ratio here.
As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.