Today we are going to look at China Unicom (Hong Kong) Limited (HKG:762) 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
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?
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 China Unicom (Hong Kong):
0.034 = CN¥12b ÷ (CN¥562b - CN¥205b) (Based on the trailing twelve months to March 2020.)
Therefore, China Unicom (Hong Kong) has an ROCE of 3.4%.
Does China Unicom (Hong Kong) Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, China Unicom (Hong Kong)'s ROCE appears meaningfully below the 6.1% average reported by the Telecom industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how China Unicom (Hong Kong) compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.6% available in government bonds. It is likely that there are more attractive prospects out there.
In our analysis, China Unicom (Hong Kong)'s ROCE appears to be 3.4%, compared to 3 years ago, when its ROCE was 1.4%. This makes us think the business might be improving. You can see in the image below how China Unicom (Hong Kong)'s ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 China Unicom (Hong Kong).
What Are Current Liabilities, And How Do They Affect China Unicom (Hong Kong)'s 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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.
China Unicom (Hong Kong) has current liabilities of CN¥205b and total assets of CN¥562b. As a result, its current liabilities are equal to approximately 36% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, China Unicom (Hong Kong)'s ROCE is concerning.
The Bottom Line On China Unicom (Hong Kong)'s ROCE
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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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