Today we are going to look at CGN Mining Company Limited (HKG:1164) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First, we'll go over how we 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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 CGN Mining:
0.0059 = HK$12m ÷ (HK$2.4b - HK$378m) (Based on the trailing twelve months to June 2019.)
Therefore, CGN Mining has an ROCE of 0.6%.
Does CGN Mining Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see CGN Mining's ROCE is meaningfully below the Oil and Gas industry average of 7.6%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how CGN Mining compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.6% available in government bonds. Readers may wish to look for more rewarding investments.
We can see that, CGN Mining currently has an ROCE of 0.6%, less than the 28% it reported 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how CGN Mining's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. Remember that most companies like CGN Mining are cyclical businesses. How cyclical is CGN Mining? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How CGN Mining's Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
CGN Mining has total assets of HK$2.4b and current liabilities of HK$378m. As a result, its current liabilities are equal to approximately 16% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
Our Take On CGN Mining's ROCE
That's not a bad thing, however CGN Mining has a weak ROCE and may not be an attractive investment. But note: make sure you look for a great company, not just the first idea you come across. 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 are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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