Today we'll evaluate CI Resources Limited (ASX:CII) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
How Do You Calculate Return On Capital Employed?
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 CI Resources:
0.055 = AU$13m ÷ (AU$253m - AU$20m) (Based on the trailing twelve months to June 2019.)
So, CI Resources has an ROCE of 5.5%.
Does CI Resources Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, CI Resources's ROCE appears to be significantly below the 7.9% average in the Metals and Mining industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how CI Resources stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
CI Resources's current ROCE of 5.5% is lower than its ROCE in the past, which was 22%, 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how CI Resources's ROCE compares to its industry. Click to see more on 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. Given the industry it operates in, CI Resources could be considered cyclical. If CI Resources is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect CI Resources's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
CI Resources has total assets of AU$253m and current liabilities of AU$20m. Therefore its current liabilities are equivalent to approximately 7.8% of its total assets. CI Resources reports few current liabilities, which have a negligible impact on its unremarkable ROCE.
Our Take On CI Resources's ROCE
If performance improves, then CI Resources may be an OK investment, especially at the right valuation. 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).
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.