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Don’t Buy K.M. Sugar Mills Limited (NSE:KMSUGAR) Until You Understand Its ROCE

Simply Wall St

Today we'll evaluate K.M. Sugar Mills Limited (NSE:KMSUGAR) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. 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.'

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 K.M. Sugar Mills:

0.11 = ₹228m ÷ (₹4.9b - ₹2.8b) (Based on the trailing twelve months to June 2019.)

Therefore, K.M. Sugar Mills has an ROCE of 11%.

See our latest analysis for K.M. Sugar Mills

Does K.M. Sugar Mills Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see K.M. Sugar Mills's ROCE is around the 12% average reported by the Food industry. Putting aside K.M. Sugar Mills's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.

K.M. Sugar Mills's current ROCE of 11% is lower than 3 years ago, when the company reported a 28% ROCE. Therefore we wonder if the company is facing new headwinds. The image below shows how K.M. Sugar Mills's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NSEI:KMSUGAR Past Revenue and Net Income, September 10th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. How cyclical is K.M. Sugar Mills? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Do K.M. Sugar Mills's Current Liabilities Skew Its ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

K.M. Sugar Mills has total liabilities of ₹2.8b and total assets of ₹4.9b. Therefore its current liabilities are equivalent to approximately 56% of its total assets. This is a fairly high level of current liabilities, boosting K.M. Sugar Mills's ROCE.

The Bottom Line On K.M. Sugar Mills's ROCE

K.M. Sugar Mills's ROCE in absolute terms is poor, and there are likely better investment prospects out there. Of course, you might also be able to find a better stock than K.M. Sugar Mills. So you may wish to see this free collection of other companies that have grown earnings strongly.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.

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. Thank you for reading.