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What Can We Make Of Canfor Pulp Products Inc.’s (TSE:CFX) High Return On Capital?

Simply Wall St

Today we’ll evaluate Canfor Pulp Products Inc. (TSE:CFX) to determine whether it could have potential as an investment idea. 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. And finally, we’ll look at how its current liabilities are impacting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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?

Analysts use this formula to calculate return on capital employed:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)

Or for Canfor Pulp Products:

0.33 = CA$244m ÷ (CA$932m – CA$182m) (Based on the trailing twelve months to December 2018.)

Therefore, Canfor Pulp Products has an ROCE of 33%.

See our latest analysis for Canfor Pulp Products

Is Canfor Pulp Products’s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Canfor Pulp Products’s ROCE is meaningfully higher than the 15% average in the Forestry industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Canfor Pulp Products’s ROCE currently appears to be excellent.

As we can see, Canfor Pulp Products currently has an ROCE of 33% compared to its ROCE 3 years ago, which was 20%. This makes us think the business might be improving.

TSX:CFX Past Revenue and Net Income, March 7th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during 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 Canfor Pulp Products.

Do Canfor Pulp Products’s Current Liabilities Skew Its ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Canfor Pulp Products has total assets of CA$932m and current liabilities of CA$182m. Therefore its current liabilities are equivalent to approximately 20% of its total assets. The fairly low level of current liabilities won’t have much impact on the already great ROCE.

Our Take On Canfor Pulp Products’s ROCE

Low current liabilities and high ROCE is a good combination, making Canfor Pulp Products look quite interesting. But note: Canfor Pulp Products may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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 editorial-team@simplywallst.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.