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1 Simple Number For Understanding 3 Important Areas Of First Resources Ltd’s Business

First Resources Ltd (SGX: EB5) is an integrated palm oil producer that manages more than 210,000 hectares of oil palm plantations across the Riau, East Kalimantan, and West Kalimantan provinces of Indonesia. It organizes its business into three segments: Crude Palm Oil (CPO); Palm Kernel; and Refinery and Processing.

In this article, I want to dig deep into First Resources’ return on equity, or ROE.

The choice of ROE

Why the ROE some of you might be asking? That’s because the financial metric gives investors important insight on a company’s ability to generate a profit using the shareholders’ capital it has.

A ROE of 20% means that a company generates $0.20 in profit for every dollar of shareholders’ capital invested. In general, the higher the ROE, the more profitable a company is. A high ROE can also be a sign that a company has a high quality business.

That being said, it’s worth noting that the use of high leverage – which increases the financial risk faced by a company – can also increase a company’s ROE. So, that’s something to observe.

Calculating the ROE

The ROE can be calculated using the following formula, which is the way many investors do it:

ROE = Net Profit / Shareholder’s Equity

But, the ROE can also be calculated using a different approach shown below:

ROE = Asset Turnover x Net Profit Margin x Leverage Ratio

Doing so will reveal three important aspects about a company: How well it is managing its assets, how efficient it is at turning revenue into profit, and how much financial risk it could be taking on. For more information about this formula for the ROE, you can check out here.

With that, let’s turn our attention to the ROE of First Resources.

The actual numbers

The asset turnover measures the efficiency of a company in using its assets to generate revenue. It is calculated by dividing a company’s total revenue by its assets. For First Resources, it had total revenue of US$647.0 million, and total assets of US$ 1,731.0 million, in 2017. This gives a low asset turnover of 0.374.

The net profit margin measures the percentage of revenue that is left as a profit after deduction of all expenses. In FY2017, First Resources had a healthy net profit margin of 22.4%, given its net profit of US$145.2 million and revenue of US$647.0 million.

Lastly, we have the leverage ratio, which shows the relationship of a company’s total assets to its equity. It is calculated by dividing total assets by equity. A higher ratio means that a company is funding its assets with more liabilities, hence resulting in higher risk. In 2017, First Resources had total assets and total equity of US$1.731 billion and US$1.022 billion, respectively. This gives an acceptable leverage ratio of 1.69.

When we put all the numbers together, we arrive at a respectable ROE of 14.2%.

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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 Lawrence Nga doesn’t own shares in any companies mentioned.