Does The Market Have A Low Tolerance For Airtel Africa Plc's (LON:AAF) Mixed Fundamentals?

editorial-team@simplywallst.com (Simply Wall St)

Wed, Aug 21, 2024, 11:37 PM 4 min read

It is hard to get excited after looking at Airtel Africa's (LON:AAF) recent performance, when its stock has declined 4.8% over the past three months. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on Airtel Africa's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Airtel Africa

How Do You Calculate Return On Equity?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Airtel Africa is:

4.0% = US$93m ÷ US$2.3b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.04 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Airtel Africa's Earnings Growth And 4.0% ROE

At first glance, Airtel Africa's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 5.1% either. For this reason, Airtel Africa's five year net income decline of 7.0% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.

However, when we compared Airtel Africa's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 2.2% in the same period. This is quite worrisome.

past-earnings-growth — LSE:AAF Past Earnings Growth August 22nd 2024

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is AAF fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Airtel Africa Making Efficient Use Of Its Profits?

In spite of a normal three-year median payout ratio of 31% (that is, a retention ratio of 69%), the fact that Airtel Africa's earnings have shrunk is quite puzzling. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Moreover, Airtel Africa has been paying dividends for five years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 34%. However, Airtel Africa's ROE is predicted to rise to 48% despite there being no anticipated change in its payout ratio.

Summary

On the whole, we feel that the performance shown by Airtel Africa can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.