ROIC

ROIC, or return on invested capital, is used as a general measure for the operations of a company’s profitability. ROIC communicates a percentage of the return on capital invested in a firm’s net operating assets. ROIC is an important component in a valuation, as a greater ROIC, assuming everything else remains constant, yields a greater predicted value. The greater the ROIC, the lesser is the cost of financing. As per Petersen & Plenborg (2012), ROIC is calculated as such:

𝑅𝑂𝐼𝐶 = 𝑁𝑒𝑡 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡 𝐴𝑓𝑡𝑒𝑟 𝑇𝑎𝑥 (𝑁𝑂𝑃𝐴𝑇) (𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝑐𝑎𝑝𝑖𝑡𝑎𝑙₀+ 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝑐𝑎𝑝𝑖𝑡𝑎𝑙_0LM)

2

When making sense of ratios in general, and ROIC in particular, it is essential to focus on both the growth over time as well as the level of return. To determine the level of return, one can either compare it to the weighted average cost of capital (WACC) or by benchmarking and comparing it with its peer group. Nevertheless, Petersen & Plenborg (2012) argue that the latter is the optimal way of assessing development. Additional benchmarking and comparison against peers may uncover whether changes in returns should be attributed to firm- or industry-specific factors.

58 Figure 17: ROIC

Source: Thomson One Banker / Scatec Solar ASA 2014abc & 2015-2017acde & 2018b / Own creation

Figure 17 demonstrates SSO’s quarterly development in ROIC in comparison with its peer group.

Apart from Q2 2017 and Q4 2017, SSO has experienced a positive quarterly growth since its IPO in 2014. This indicates that operating profitability is increasing. To contextualize, the ROIC was 0.91% in Q1 of 2014, and reached an all-time high of 2.78% in Q3 of 2017, decreasing to -0.27% in Q4 the same year.

An annual perspective of the ROIC reveals a generally positive development for SSO, who

outperformed every peer in 2016 but experienced a dramatic decline in Q2 of 2017. This is not due to a decline in operating income, as figure 16 demonstrates; SSO has a healthy operating profit (in

comparison to itself in earlier years as well as its peers). This sudden decline in ROIC is mainly caused by abnormally large tax fees. A surprising finding is First Solar’s solid ROIC performance in

comparison to EBITDA-margin. Overall, SSO has demonstrated that it is able to deliver an above

59 average ROIC in ten out of the last sixteen quarters. Barring Q2 and Q4 of 2017, SSO has consistently given investors a positive ROIC.

As previously mentioned, ROIC performance can also be assessed by comparing it to the WACC. If SSO generates a ROIC that exceeds that of its WACC, it generates so-called above-normal profit (Petersen & Plenborg, 2012). The figure below depicts the relationship between SSO’s ROIC and WACC. It shows that SSO generates an inferior ROIC compared to WACC, not indicating above normal profits. Despite this, the peer comparison still shows that it performs above average in all years barring 2017.

Figure 18: ROIC vs WACC

Source: Thomson One Banker / Scatec Solar ASA 2014abc & 2015-2017acde & 2018b / Own creation

To get a deeper understanding of ROIC and the factors that drive its growth, it is essential to perform a decomposition of ROIC. The next section will be devoted to this matter.

Decomposition of ROIC

As previously mentioned, ROIC measures a firm’s return on invested capital in operations. In order to gain a deeper understanding of its dynamics, a decomposition will be performed. ROIC is divided into two drivers; profit margin (PM) and turnover rate of invested capital (TO). This decomposition should

60 provide the same result as the ROIC formula in the previous section and is computed by the following formula:

𝑅𝑂𝐼𝐶 = 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 ×𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑒 𝑜𝑓 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 Profit Margin

The relationship between a company’s expenses and revenues is explained by the profit margin, which is shown as a percentage of net revenue (Petersen & Plenborg, 2012). Generally, the higher the profit margin, the more attractive a company is. The profit margin signifies how much a company generates on each dollar of net revenue and is computed by the following formula

𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 = 𝑁𝑂𝑃𝐴𝑇

𝑁𝑒𝑡 𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 ×100 Figure 19: Quarterly Profit Margins

Source: Thomson One Banker / Scatec Solar ASA 2014abc & 2015-2017acde & 2018b / Own creation

As one can see from figure 19, SSO has kept a relatively steady profit margin since 2014, triumphing over all its peers in eight out of the sixteen quarters analyzed. It increased its profit margin from 31% in Q1 2014 to 57% in Q3 2017, and appears to have only been outperformed by Innergex. Petersen and Plenborg (2012) also note that commodity providers have an upper limit to their profit margin, as price

61 is generally the most prominent driver due to the difficulty in differentiating a commodity. The

negative PM in 2017 is mainly due to extremely high tax expenses in Q2 and Q4 of the same year.

Turnover rate of invested capital

The turnover rate conveys a firm’s ability of utilizing their invested capital (Petersen & Plenborg, 2012). To determine the number of days the invested capital is tied up, one can divide the number of days in a year by the turnover rate. Generally, having a high turnover rate, ceteris paribus, is attractive.

Turnover rate is computed as;

𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑒 = 𝑁𝑒𝑡 𝑅𝑒𝑣𝑒𝑛𝑢𝑒

(𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝐶𝑎𝑝𝑖𝑡𝑎𝑙_0Q+ 𝐼𝑛𝑣𝑒𝑠𝑡𝑒𝑑 𝑐𝑎𝑝𝑖𝑡𝑎𝑙₀₁₂) 2

As seen in figure 20 the turnover rate is generally low within this peer group, meaning that capital is tied up over a long time. According to Petersen & Plenborg (2012), this is normal among heavy investment companies. SSO’s turnover rate increased from 0,03 in Q1 2014 to 0,04 in Q4 2017.

Nevertheless, SSO’s TO stays below the peer average during the whole period, demonstrating a relatively constant trend, with slight increases. The increase in TO might be attributed to a more efficient asset utilization. From 2015 to 2016, revenue grew by 16.74%, whereas invested capital grew by 14.23%. From 2016 to 2017, revenues grew by 10.67% while invested capital grew by 0.59%. This suggests that SSO generates more net revenue per krone of invested capital. It is also evident that First Solar is outperforming the peer group as a whole, with SSO trailing behind from the three most recent years

62 Figure 20: Quarterly Turnover Rates

Source: Thomson One Banker / Scatec Solar ASA 2014abc & 2015-2017acde & 2018b / Own creation

SSO’s low turnover rate could be explained by the fact that their invested capital is greatly impacted by their property, plant and equipment (PPE), which accounts for approximately 88%, of their total non-current operating assets, in the fiscal year of 2017. A quarterly turnover rate of 0.0445 indicates that invested capital is tied up in 2021.09 days, i.e. 5,61 years. This is well aligned with the fact that the duration of PPA contracts is long, normally between 20 to 25 years, which is also the conventional time horizon for projects (IEA, 2017a). Barring First Solar, SSO has a higher TO than its peer group.

By conducting a decomposition of the ROIC, it has become clear that SSO’s ROIC has primarily been driven by their profit margin. The TO has remained relatively constant and low, while the high-profit margin has ensured a healthy, above-average, ROIC, which turned negative in Q2 2017 due to negative PM.