Today we are going to look at AltaGas Ltd. (TSE:ALA) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
So, How Do We Calculate ROCE?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for AltaGas:
0.04 = CA$681m ÷ (CA$21b - CA$3.9b) (Based on the trailing twelve months to June 2019.)
So, AltaGas has an ROCE of 4.0%.
Does AltaGas Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, AltaGas's ROCE appears meaningfully below the 7.3% average reported by the Gas Utilities industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how AltaGas compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.9% available in government bonds. It is likely that there are more attractive prospects out there.
You can see in the image below how AltaGas's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for AltaGas.
What Are Current Liabilities, And How Do They Affect AltaGas's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
AltaGas has total assets of CA$21b and current liabilities of CA$3.9b. As a result, its current liabilities are equal to approximately 18% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
The Bottom Line On AltaGas's ROCE
While that is good to see, AltaGas has a low ROCE and does not look attractive in this analysis. You might be able to find a better investment than AltaGas. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.