A Look At 1 Important Investing Formula For BreadTalk Group Limited

The return on equity (ROE) metric measures a company’s ability to generate a profit with the shareholders’ capital it has.

Generally speaking, a high ROE is preferred over a low one, all things being equal.

But, the ROE alone does not tell the whole story with a company. It can actually be broken down into greater detail to provide even more useful insight. Here is the breakdown:

ROE = Profit Margin x Asset Turnover x Equity Multiplier

Some of you might quickly recognize this as the DuPont analysis, which was invented in the 1920s by well, the DuPont Corporation. It was initially used to measure the company’s internal efficiency.

In this piece, let’s use the formula on BreadTalk Group Limited (SGX: 5DA). As a quick background, BreadTalk may be best known for its signature pork floss buns that it sells in its namesake BreadTalk bakeries all around Asia. The company also runs restaurants and food atriums under various brands.

The following chart shows how the ROE has been for BreadTalk Group over its last five fiscal years:

Breadtalk ROE chart
Source: BreadTalk’s annual report

As you can see, BreadTalk’s ROE has plunged from nearly 16% in 2011 to just 6.0% in 2015. What’s going on here? We can get down to business and breakdown BreadTalk’s ROE.

Breadtalk Dupont chart
Source: BreadTalk’s annual report

From 2011 to 2015, BreadTalk’s profit margin had stepped down from 3.2% to 1.2%. This could be a sign that BreadTalk has not been able to effectively pass on cost increases to consumers.

To illustrate how severe falling margins can be for shareholders, a peep into the financials reveals that BreadTalk has actually enjoyed strong revenue growth. From 2011 to 2015, BreadTalk’s revenue soared from $366 million to $624 million. Yet, earnings per share actually dropped from S$0.0412 per share to S$0.0270 per share.

BreadTalk has not performed well either when it comes to the asset turnover. The asset turnover measures how good BreadTalk is at utilizing it assets to generate revenue. Generally, a higher asset turnover translates to a better performance. It is calculated by dividing revenue with assets.

As mentioned, BreadTalk’s revenue has grown over the past five years. But its assets have grown at a faster pace, more than doubling from S$262 million to S$545 million. These have resulted in the asset turnover falling. The company’s ability to sweat its assets has declined these past few years. When this is coupled with BreadTalk’s falling profit margin, it could be a sign that the company’s expansion in the past few years has been too aggressive.

The final element in the DuPont formula is the equity multiplier, which measures how much leverage a company is taking on. Leverage can magnify returns; hence higher leverage generally results in a higher ROE.

We can see that equity multiplier for BreadTalk has actually been rising over the years. The company’s bank borrowings had climbed from S$39.3 million in 2011 to S$201.7 million in 2015. Yet, shareholders did not get to enjoy a higher ROE.

A Fool’s take

To sum up what the DuPont formula has showed us, BreadTalk’s expansion strategy has not been all rosy for its shareholders. Despite taking on higher leverage (and hence more financial risks), the company’s ROE had fallen because of a lower profit margin and asset turnover.

While this deeper study of BreadTalk’s ROE has provided us with some useful insight, it should only be seen as a starting point for further research. More work needs to be done before any firm investing conclusion can be made on BreadTalk.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Wilson Ong doesn’t own shares in any companies mentioned.