Today we'll look at Yanzhou Coal Mining Company Limited (HKG:1171) and reflect on its potential as an investment. 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. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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 Yanzhou Coal Mining:
0.11 = CN¥16b ÷ (CN¥198b - CN¥59b) (Based on the trailing twelve months to September 2019.)
So, Yanzhou Coal Mining has an ROCE of 11%.
Does Yanzhou Coal Mining Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Yanzhou Coal Mining's ROCE is meaningfully higher than the 7.6% average in the Oil and Gas industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Separate from Yanzhou Coal Mining's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Our data shows that Yanzhou Coal Mining currently has an ROCE of 11%, compared to its ROCE of 1.8% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how Yanzhou Coal 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. We note Yanzhou Coal Mining could be considered a cyclical business. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Yanzhou Coal Mining's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.
Yanzhou Coal Mining has current liabilities of CN¥59b and total assets of CN¥198b. Therefore its current liabilities are equivalent to approximately 30% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On Yanzhou Coal Mining's ROCE
With that in mind, Yanzhou Coal Mining's ROCE appears pretty good. There might be better investments than Yanzhou Coal Mining 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.
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 firstname.lastname@example.org. 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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