Valmont Industries, Inc.’s (NYSE: VMI) most recent return on equity was a below average 10.5% in comparison to the Industrials sector which returned 10.6%. Though Valmont’s performance over the past twelve months is subpar, it’s useful to understand how the company achieved its low ROE. Was it a result of profit margins, operating efficiency or maybe even leverage? Knowing these components may change your views on Valmont and its future prospects.
ROE Trends Of Valmont
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 Valmont is shown below.
source: finbox.io data explorer – ROE
The return on equity of Valmont has generally been declining over the last few years. ROE increased from 3.6% to 17.8% in fiscal year 2016, decreased to 10.9% in 2017 and decreased again to 10.5% as of LTM Mar’18. So what’s causing the general decline?
Valmont’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 Valmont’s returns.
Net Profit Margin
The net profit margin of Valmont has generally been declining over the last few years. Margins increased from 1.5% to 6.9% in fiscal year 2016, decreased to 4.2% in 2017 and decreased again to 4.2% as of LTM Mar’18.
Therefore, the company’s decreasing margins help explain, at least partially, why ROE is also decreasing. Now let’s take a look at Valmont’s efficiency performance.
A promising sign for shareholders, Valmont’s asset turnover has increased each year since 2015. Turnover increased from 1.02x to 1.05x in fiscal year 2016, increased to 1.10x in 2017 and increased again to 1.10x as of LTM Mar’18.
source: data explorer – asset turnover
Therefore, the company’s ROE decline is not as a result of its asset turnover performance which has been steadily increasing.
Finally, the DuPont constituents that make up Valmont’s ROE are shown in the table below. Note that the table also compares Valmont to a peer group that includes Lindsay Corporation(NYSE: LNN), Quanta Services, Inc. (NYSE: PWR), AECOM (NYSE: ACM) and Fluor Corporation(NYSE: FLR).
source: finbox.io’s DuPont model
In conclusion, the DuPont analysis has helped us better understand that Valmont’s general decline in return on equity is the result of a worsening net profit margin, an improving asset turnover ratio and declining leverage. Therefore when looking at the core operations of the business, Valmont shareholders don’t necessarily need to panic just yet due to the company’s general decline in profitability along with a steady improvement 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 Valmont by taking a look at the following:
Valuation Metrics: what is Valmont’s free cash flow yield and how does it compare to its publicly traded peers? This metric measures the amount of free cash flow for each dollar of equity (market capitalization). Analyze the free cash flow yield here.
Risk Metrics: what is Valmont’s cash ratio which is used to assess a company’s short-term liquidity. View the company’s cash ratio here.
Efficiency Metrics: return on equity is used to measure the return that a firm generates on the book value of common equity. View Valmont’s return on equity 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.