Today we are going to look at Target Hospitality Corp. (NASDAQ:TH) 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.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding 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. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 Target Hospitality:
0.12 = US$64m ÷ (US$609m - US$65m) (Based on the trailing twelve months to June 2019.)
So, Target Hospitality has an ROCE of 12%.
Does Target Hospitality Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Target Hospitality's ROCE appears to be substantially greater than the 8.9% average in the Hospitality industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Target Hospitality compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
The image below shows how Target Hospitality's ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Target Hospitality'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.
Target Hospitality has total liabilities of US$65m and total assets of US$609m. As a result, its current liabilities are equal to approximately 11% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On Target Hospitality's ROCE
With that in mind, Target Hospitality's ROCE appears pretty good. There might be better investments than Target Hospitality out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like Target Hospitality 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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