Today we'll evaluate Southern Energy Holdings Group Limited (HKG:1573) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
Firstly, we'll go over how we calculate ROCE. 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. In general, businesses with a higher ROCE are usually better quality. 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.
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 Southern Energy Holdings Group:
0.21 = CN¥281m ÷ (CN¥1.7b - CN¥316m) (Based on the trailing twelve months to June 2019.)
So, Southern Energy Holdings Group has an ROCE of 21%.
Does Southern Energy Holdings Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Southern Energy Holdings Group's ROCE appears to be substantially greater than the 7.5% average in the Oil and Gas industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, Southern Energy Holdings Group's ROCE in absolute terms currently looks quite high.
Southern Energy Holdings Group's current ROCE of 21% is lower than 3 years ago, when the company reported a 37% ROCE. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Southern Energy Holdings Group'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. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. We note Southern Energy Holdings Group could be considered a cyclical business. How cyclical is Southern Energy Holdings Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Southern Energy Holdings Group's Current Liabilities And Their Impact On 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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Southern Energy Holdings Group has total assets of CN¥1.7b and current liabilities of CN¥316m. As a result, its current liabilities are equal to approximately 19% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.
The Bottom Line On Southern Energy Holdings Group's ROCE
Low current liabilities and high ROCE is a good combination, making Southern Energy Holdings Group look quite interesting. Southern Energy Holdings Group looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
I will like Southern Energy Holdings Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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