What Can We Make Of Danone S.A.’s (EPA:BN) High Return On Capital?
Today we'll look at Danone S.A. (EPA:BN) and reflect on its potential as an investment. 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.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting 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. 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?
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 Danone:
0.12 = €4.0b ÷ (€45b - €11b) (Based on the trailing twelve months to December 2019.)
So, Danone has an ROCE of 12%.
View our latest analysis for Danone
Does Danone Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, we find that Danone's ROCE is meaningfully better than the 7.5% average in the Food industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Danone's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
In our analysis, Danone's ROCE appears to be 12%, compared to 3 years ago, when its ROCE was 8.8%. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Danone's past growth compares to other companies.
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. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Danone.
Do Danone's Current Liabilities Skew 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 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.
Danone has current liabilities of €11b and total assets of €45b. Therefore its current liabilities are equivalent to approximately 25% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Danone's ROCE
With that in mind, Danone's ROCE appears pretty good. Danone shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.
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. Thank you for reading.
