As analyzed earlier, the single project EIRR and ROE are confusing. How to measure the return on investment of green power companies after adding financing leverage?
Illusion 2 of the ROE of individual green power projects: the asset-liability ratio of individual projects continues to decline
In a single green power project with 100% dividends in net profit, although the total assets of the project are declining year by year with the continuous depreciation of project fixed assets (we assume that the net cash flow generated by depreciation does not distribute dividends, so the net assets remain unchanged ), but the rate of decline in project interest-bearing liabilities is faster. Therefore, in the whole life cycle, the asset-liability ratio of a single project continues to decline. When the loan is repaid, the asset-liability ratio of the individual project will drop to 0. For example, we observe a 15-year project with equal repayment of principal and interest, as shown in the figure below:
In the 14th year, the asset-liability ratio of the project has dropped to 25.1%. From the 16th year, the asset-liability ratio of the project is 0 until the end of the whole life cycle.
Friends who have experience in green power investment may wish to look at the consolidated statements of green power companies. It can be found that with the passage of time, the asset-liability ratio of the consolidated statements of green power companies has not declined, but has remained stable throughout the year, or remained near the upper limit of the liability ratio allowed by the supervision. This is a clear departure from the single-project model.
This shows that after the repayment of loan principal and interest for individual projects, newly invested and developed projects have obtained new bank loans.
Moreover, it is still not enough to keep the debt ratio at the consolidated statement level not to decline only by relying on continuous loan acquisition at the project level. This is a mathematical problem. Just imagine that several individual projects with declining asset-liability ratios are superimposed together, and the total asset-liability ratio is still declining.
In order to maintain the asset-liability ratio at the consolidated statement level, in addition to increasing the leverage at the initial stage of new development projects, it is also necessary to continuously increase liabilities at the parent company level. In this way, the asset-liability ratio at the consolidated statement level can be maintained without falling.
Therefore, the ROE level of individual projects we see underestimates the overall capital profitability of green power companies. Because in a single project, the interest-bearing liabilities that the capital can rely on are constantly decreasing. At the overall level of the company, the leverage level can be kept from falling through continuous borrowing. The profitability of capital under the condition that the level of leverage does not decrease is the real ROE level of green power companies.
Profitability “Extreme Formula”
Without considering all capital redundancy, the capital profitability of green power companies should be equal to “full investment IRR + interest rate spread * leverage ratio”. ROE=IRR+(IRR-LR)*S, where: LR is the loan interest rate, and S is the leverage ratio.
Of course this is just a theoretical formula. In actual operation, due to the existence of many redundant capitals (such as construction in progress), the ROE of green power companies is less than the limit ROE. This requires an analysis of the trends in the amount of redundant capital in various companies and the reasons for capital redundancy.
Series review:
Green Code 1: Amazing Models
Green Power Code 2: Illusion of Capital Return (EIRR)
Green Power Code 3: The business model of green power has shifted from “high leverage” to “cash cow”
Green Power Code 4: The ROE of a single project is also an illusion
Green Power Code 5: All-investment IRR has universal comparative significance
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