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Examining Cameco Corporation’s (TSE:CCO) Weak Return On Capital Employed

Simply Wall St

Today we are going to look at Cameco Corporation (TSE:CCO) to see whether it might be an attractive investment prospect. 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. 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 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. 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 Cameco:

0.036 = CA$259m ÷ (CA$8.1b - CA$823m) (Based on the trailing twelve months to June 2019.)

So, Cameco has an ROCE of 3.6%.

View our latest analysis for Cameco

Is Cameco's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. We can see Cameco's ROCE is meaningfully below the Oil and Gas industry average of 5.6%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Cameco's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.

The image below shows how Cameco's ROCE compares to its industry, and you can click it to see more detail on its past growth.

TSX:CCO Past Revenue and Net Income, October 5th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Remember that most companies like Cameco are cyclical businesses. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Cameco'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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Cameco has total liabilities of CA$823m and total assets of CA$8.1b. Therefore its current liabilities are equivalent to approximately 10% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.

What We Can Learn From Cameco's ROCE

While that is good to see, Cameco has a low ROCE and does not look attractive in this analysis. 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.

Cameco is not the only stock that insiders are buying. 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.