Crown Holdings, Inc.’s (NYSE: CCK) most recent return on equity was an outstanding 40.6% in comparison to the Materials sector which returned 6.1%. Though Crown’s performance over the past twelve months is highly impressive, it’s useful to understand how the company achieved its strong ROE. Was it a result of profit margins, operating efficiency or maybe even leverage? Knowing these components may change your views on Crown and its future prospects.
ROE Trends Of Crown
Return on equity (ROE) is the amount of net income returned as a percentage of shareholders equity. It is calculated as follows:
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. But it is important to note that ROE can be impacted by management’s financing decisions such as the deployment of leverage.
The return on equity of Crown is shown below.
source: finbox.io data explorer – ROE
Unfortunately for shareholders, Crown’s return on equity has decreased each year since 2015. ROE decreased from 101.8% to 94.2% in fiscal year 2016, decreased to 40.6% in 2017 and the LTM period is also its latest fiscal year. So what’s causing the steady decline?
Crown’s Declining ROE Trends
In addition to the formula previously discussed, there’s actually another way to calculate ROE. It’s often called the DuPont formula and is as follows:
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 let’s take a closer look at the drivers behind Crown’s returns.
Net Profit Margin
The net profit margin of Crown has generally been declining over the last few years. Margins increased from 4.5% to 6.0% in fiscal year 2016, decreased to 3.7% in 2017 and the LTM period is also its latest fiscal year.
Therefore, the company’s decreasing margins help explain, at least partially, why ROE is also decreasing. Now let’s take a look at Crown’s efficiency performance.
It appears that asset turnover of Crown has generally been declining over the last few years. Turnover decreased from 0.89x to 0.84x in fiscal year 2016, increased to 0.86x in 2017 and the LTM period is also its latest fiscal year.
source: data explorer – asset turnover
Therefore, the company’s decreasing asset turnover ratio helps explain, at least partially, why ROE is also decreasing.
Finally, the DuPont constituents that make up Crown’s ROE are shown in the table below. Note that the table also compares Crown to a peer group that includes Owens-Illinois, Inc. (NYSE: OI), Ball Corporation (NYSE: BLL), Berry Plastics Group, Inc. (NYSE: BERY) and Sealed Air Corporation (NYSE: SEE).
source: finbox.io’s DuPont model
In conclusion, the DuPont analysis has helped us better understand that Crown’s continuous fall in return on equity is the result of a worsening net profit margin, a declining asset turnover ratio and declining leverage. Therefore when looking at the core operations of the business, Crown shareholders have reason to be concerned due to the company’s general decline in profitability along with a general decline in operational efficiency and declining leverage.
The DuPont approach is a helpful tool when analyzing how well management is utilizing shareholder capital. However, it doesn’t necessarily tell the whole story. If you have not done so already, I highly recommend that you complete your research on Crown by taking a look at the following:
Valuation Metrics: how much upside do shares of Crown have based on the Ben Graham Formula? Take a look at our Ben Graham Formula data explorer which also compares the company’s upside to its peers.
Risk Metrics: what is Crown’s Altman Z score? It’s a famous formula used to predict the probability that a firm will go into bankruptcy within two years. View the company’s Altman Z score here.
Efficiency Metrics: how much free cash flow does Crown generate as a percentage of total sales? Has it been increasing or decreasing over time? Review the firm’s free cash flow margin 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.