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Mandarin Oriental International Limited’s Investors Should See This Investing Formula

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

ROE = Profit Margin x Asset Turnover x Equity Multiplier

The formula may be familiar to some of you. It is actually the DuPont formula, created way back in the 1920s by the DuPont Corporation to measure its own internal efficiency.

In here, I want to use the formula on Mandarin Oriental International Limited (SGX: M04) to tease out the reasons for the changes in its ROE over the past few years. You can see how Mandarin Oriental’s ROE has been like from 2011 to 2015 in the following chart:

Mandarin Oriental ROE
Source: Mandarin Oriental’s annual report

So, Mandarin Oriental’s ROE was rising from 2011 to 2014 but took a dip in 2015. Let us now see what the DuPont formula can tell us about the phenomenon.

But first, a quick background. Mandarin Oriental is an international hotel investment and management group with properties in 19 countries and territories. The conglomerate Jardine Strategic Holdings Limited (SGX: J37) is Mandarin Oriental’s main shareholder with a three-quarter stake.

With that, we can now move on to the DuPont analysis. Here’s a chart of it:

Mandarin Oriental Dupont Analysis
Source: Mandarin Oriential’s annual report

Mandarin Oriental’s profit margin has been climbing gradually, from 11% in 2011 to 14.7% in 2015. Even though revenue was relatively stagnant in that five year block, the company managed to grow its net income, resulting in the higher profit margin.

The second component of the DuPont analysis, the asset turnover, is a measure of how good Mandarin Oriental is at utilizing its assets to generate revenue. It is calculated by dividing the company’s revenue with its assets. Generally, a higher asset turnover translates to a better performance.

Mandarin Oriental’s asset turnover has been low but stable – the company has not been actively expanding its portfolio of hotels and resorts.

The last component of the DuPont formula is the equity multiplier and it is found by dividing a company’s assets with its equity. It is a gauge for how much leverage – and thus, financial risk – Mandarin Oriental is taking on.

We can observe that the hotel group’s equity multiplier drifted down in 2015 with the equity base swelling by 28% to US$1.2 billion during the year. This was the result of a rights offering in March 2015. Some of the proceeds went towards repaying Mandarin Oriental’s borrowings, hence strengthening its balance sheet. The company ended 2015 with total debt of US$443 million, down from US$731 million in 2014.

A Fool’s take

To sum up what the DuPont formula has showed us, Mandarin Oriental’s ROE had fallen in 2015 largely as a result of its lower equity multiplier in that year. The rights offering in 2015 had strengthened the company’s balance sheet at the cost of a slimmer ROE.

It should be noted that more work needs to be done beyond the DuPont analysis before any firm investing conclusion can be made on Mandarin Oriental. This breakdown of the company’s ROE should only be seen as a useful starting point for further research.

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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.