Looking at profitability is a very important step in understanding a company. Profitability is essentially why the company exists and a key component of deciding to invest or to remain invested in a company. There are many metrics involved in calculating profitability, but for this article, I will look at Duke Energy's (NYSE:DUK) earnings and earnings growth, profit margins, profitability ratios and cash flow.
Through the above-mentioned four main metrics, we will understand more about the company's profitability. And by comparing this summary to other companies in the same sector, you will be able see which has been the most profitable.
Earnings and Earnings Growth
1. Earnings = Sales x Profit Margin
- 2010 - $14.272 billion x 9.25% = $1.320 billion
- 2011 - $14.529 billion x 11.74% = $1.706 billion
Duke Energy's earnings increased from $1.320 billion in 2010 to $1.706 billion in 2011 or an increase of 29.24%.
2. Five-year historical look at earnings growth
- 2007 - $1.500 billion, 24.20% decrease over 2006
- 2008 - $1.362 billion, 13.12% decrease
- 2009 - $1.075 billion, 26.34% decrease
- 2010 - $1.320 billion, 22.79% increase
- 2011 - $1.706 billion, 29.24% increase
In analyzing Duke Energy's earnings growth over the past five years, you can see that the company's earnings decreased from 2007 to 2009 where they hit a 5 year low of $1.075 billion. Duke Energy's earnings have increased over the past 2 years to $1.706 billion. Overall, the 2011 earnings are 13.73% higher than 2007.
3. Gross Profit = Total Sales - Cost of Sales
In analyzing a company, gross profit is very important because it indicates how efficiently management uses labor and supplies in the production process. More specifically, it can be used to calculate gross profit margin. Here are Duke Energy's gross profits for the past two years:
- 2010 - $14.272 billion - $4.925 billion = $9.347 billion
- 2011 - $14.529 billion - $5.145 billion = $9.384 billion
4. Gross Profit Margin = Gross Income / Sales
The gross profit margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).
In analyzing Duke Energy's gross margin over the past five years, the margin looks to be quite consistent. The 5 year low was in 2008 with a margin of 61.99% while the high was in 2010 with a margin of 65.49%. The 2011 gross profit margin is slightly above the 5-year average of 64.35%.
- 2007 - $8.217 billion / $12.720 billion = 64.59%
- 2008 - $8.187 billion / $13.207 billion = 61.99%
- 2009 - $8.287 billion / $12.731 billion = 65.09%
- 2010 - $9.347 billion / $14.272 billion = 65.49%
- 2011 - $9.384 billion / $14.529 billion = 64.59%
The slight increase in the gross margin implies that management was more efficient in its manufacturing and distribution during the production process in 2011 compared to the 5-year average.
5. Operating income = Total Sales - Operating Expenses
The amount of profit realized from the operations of a business after taking out operating expenses - such as cost of goods sold (COGS) or wages - and depreciation. Operating income takes the gross income (revenue minus COGS) and subtracts other operating expenses, then removes depreciation. These operating expenses are costs that are incurred from operating activities and include things such as office supplies and heat and power.
- 2010 - $2.461 billion
- 2011 - $2.769 billion
6. Operating Margin = Operating Income / Total Sales
Operating margin is a measure of the proportion of a company's revenue that is left over after paying for variable costs of production such as wages, raw materials, etc. A healthy operating margin is required for a company to be able to pay for its fixed costs such as interest on debt. If a company's margin is increasing, it is earning more per dollar of sales. The higher the margin, the better.
Duke Energy's profit margin showed a significant decrease from 2007 to 2010 as it declined each of the four years. In 2011 the company improved its margin back up around the 19% range. The 2011 operating margin of 19.06% is above the 5-year average of 18.34%.
- 2007 - $2.498 billion / $12.720 billion = 19.64%
- 2008 - $2.433 billion / $13.207 billion = 18.42%
- 2009 - $2.213 billion / $12.731 billion = 17.38%
- 2010 - $2.461 billion / $14.272 billion = 17.24%
- 2011 - $2.769 billion / $14.529 billion = 19.06%
As the 2011 operating margin went against the declining downward trend and is above the 5-year average, this implies that there has been an increase in the percentage of total sales left over after paying for variable costs of production such as wages and raw materials.
7. Net Profit Margin = Net Income / Total Sales
A ratio of profitability calculated as net income divided by revenue, or net profits divided by sales. It measures how much out of every dollar of sales a company actually keeps in earnings.
Profit margin is very useful when comparing companies in similar industries. A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. Profit margin is displayed as a percentage; a 20% profit margin, for example, means the company has a net income of $0.20 for each dollar of sales.
Duke Energy's net profit margin has shown a dip going into 2009, then a nice rebounded up to 11.74% in 2011. The 2011 net profit margin of 11.74% is still slightly below the 2007 profit margin of 11.79%.
- 2007 - $1.500 billion / $12.720 billion = 11.79%
- 2008 - $1.362 billion / $13.207 billion = 10.31%
- 2009 - $1.075 billion / $12.731 billion = 8.44%
- 2010 - $1.320 billion / $14.272 billion = 9.25%
- 2011 - $1.706 billion / $14.529 billion = 11.74%
The 2011 net profit margin of 11.74% is above the 5 year average of 10.30%. This implies that there has been an increase in the percentage of earnings that the company is able to keep compared to the company's 5-year average.
9. ROA - Return on Assets = Net Income / Total Assets
ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."
Like the Profit margin the ROA has shown a dip going into 2009, then a rebound. Like the profit margin, the 2011 ROA of 2.73% is less than the 2007 ROA of 3.02%.
- 2007 - $1.500 billion / $49.704 billion = 3.02%
- 2008 - $1.362 billion / $53.077 billion = 2.57%
- 2009 - $1.075 billion / $57.040 billion = 1.88%
- 2010 - $1.320 billion / $59.090 billion = 2.23%
- 2011 - $1.706 billion / $62.526 billion = 2.73%
The current ROA of 2.73% is above the 5-year average of 2.49%. This implies that management has been slightly more efficient at using the company's assets to generate earnings compared to its 5-year average.
10. ROE - Return on Equity = Net Income / Shareholders' Equity
As shareholders' equity is measured as a firm's total assets minus its total liabilities, ROE reveals the amount of net income returned as a percentage of shareholders' equity. The return on equity measures a company's profitability by revealing how much profit it generates with the amount shareholders have invested.
- 2007 - $1.500 billion / $21.199 billion = 7.08%
- 2008 - $1.362 billion / $20.988 billion = 6.49%
- 2009 - $1.075 billion / $21.750 billion = 4.94%
- 2010 - $1.320 billion / $22.522 billion = 5.86%
- 2011 - $1.706 billion / $22.772 billion = 7.49%
Duke Energy's ROE is also very similar to its ROA. The recovery of this metric has been better than some of the other metrics as the current ROE is above the 2007 standard. The current ROE of 7.49% is above the 5-year average of 6.37%. This reveals that the company is generating more profits compared to shareholders' equity based on the 5-year average.
11. Free Cash Flow = Operating Cash Flow - Capital Expenditure
A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (NYSE:FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt.
It is important to note that negative free cash flow is not bad in itself. If free cash flow is negative, it could be a sign that a company is making large investments. If these investments earn a high return, the strategy has the potential to pay off in the long run.
Over the past five years, Duke Energy's free cash flow has been negative four times. The only year the company posted a positive cash flow in the past 5 years was in 2008. In 2011, the company reported a negative cash flow:
- 2007 - $3.208 billion - $(3.125) billion = $83 million
- 2008 - $3.328 billion - $(4.386) billion = $(1.058) billion
- 2009 - $3,463 billion - $(4.389) billion = $(926) million
- 2010 - $4.511 billion - $(4.817) billion = $(306) million
- 2011 - $3.672 billion - $(4.372) billion = $(700) million
In 4 of the past 5 years the company has run negative free cash. The negative free cash indicates that Duke Energy has been making large investments and upgrades with there free cash. Some examples of these investments are: Duke Energy's acquisition of progress energy and Duke Energy's acquisition of solar power in 2010. Looking forward, Duke energy is always looking for acquisitions to add to the company. This is stated in an article "Duke Energy Seeks Fresh Merger Prospects". This is an area to keep an eye on with the company and be mindful of the investments that the company is making.
12. Cash Flow Margin = Cash Flow from Operating Activities / Total Sales
The higher the percentage, the more cash available from sales.
If a company is generating a negative cash flow, it shows up as a negative number in the numerator in the cash flow margin equation. This means that even as the company is generating sales revenue, it is losing money. The company will have to borrow money or raise money through investors in order to keep on operating.
Duke Energy's cash flow margin is positive, so it does not have to take these measures to continue operating.
- 2007 - $3.208 billion / $12.720 billion = 25.22%
- 2008 - $3.328 billion / $13.207 billion = 25.20%
- 2009 - $3.463 billion / $12.731 billion = 27.20%
- 2010 - $4.511 billion / $14.272 billion = 31.60%
- 2011 - $3.672 billion / $14.529 billion = 25.27%
In analyzing Duke Energy's earnings growth over the past five years, you can see that the company's earnings decreased from 2007 to 2009, where in 2009 the company hit a 5 year low of $1.075 billion. The earnings have increased over the past 2 years to $1.706 billion from a low of $1.075 billion. Overall, the 2011 earnings are 13.73% higher than 2007.
As illustrated above and using a 5 year time frame, the listed profit margins show a decline until 2009 then a recovery. In most cases the recovery is very close to or exceeded to the 2007 results.
Like the profitability margins, the ROA and ROE show similar results. The ROA's recovery is slightly less than the 2007 result while the ROE has exceeded the 2007 result.
In four of the past five years, Duke Energy has shown negative cash flow. In 2011, the company reported negative cash at $(700) million. The negative cash flow that the company reports is due to the company's acquisitions and upgrades. As this is part of the company's business model this is not a concern. The real concern moving forward would be if the company's cash flow margin was sinking, but as the cash flow margin showed positive results at 25.27%; this implies that the company has the ability to develop new products, make acquisitions, pay dividends and reduce debt without having to borrow or raise money to maintain operations.
The analysis of Duke Energy's profitability reveals a very solid company with positive profitability margins, earnings and a positive cash flow margin. Based on the profitability analysis above, one concern for investing in the company would be watching the acquisitions and how they relate to the margins moving forward.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.