What Does Fresnillo PLC’s (LON:FRES) 16% ROCE Say About The Business?
Today we’ll evaluate Fresnillo PLC (LON:FRES) to determine whether it could have potential as an investment idea. 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 of all, we’ll work out how to 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 measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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’.
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 Fresnillo:
0.16 = US$786m ÷ (US$4.7b – US$134m) (Based on the trailing twelve months to June 2018.)
So, Fresnillo has an ROCE of 16%.
See our latest analysis for Fresnillo
Is Fresnillo’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see Fresnillo’s ROCE is around the 14% average reported by the Metals and Mining industry. Regardless of where Fresnillo sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Our data shows that Fresnillo currently has an ROCE of 16%, compared to its ROCE of 6.8% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.
It is important to remember that ROCE shows past performance, and is 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. ROCE is, after all, simply a snap shot of a single year. We note Fresnillo could be considered a cyclical business. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Fresnillo.
Fresnillo’s Current Liabilities And Their Impact On 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Fresnillo has total assets of US$4.7b and current liabilities of US$134m. Therefore its current liabilities are equivalent to approximately 2.8% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), Fresnillo earns a sound return on capital employed.
Our Take On Fresnillo’s ROCE
If Fresnillo can continue reinvesting in its business, it could be an attractive prospect. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
