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Are Hexcel Corporation’s (NYSE:HXL) High Returns Really That Great?

Lester Strauss

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Today we’ll look at Hexcel Corporation (NYSE:HXL) and reflect on its potential as an investment. 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. And finally, we’ll look at how its current liabilities are impacting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 Hexcel:

0.15 = US$379m ÷ (US$2.8b – US$327m) (Based on the trailing twelve months to December 2018.)

Therefore, Hexcel has an ROCE of 15%.

View our latest analysis for Hexcel

Is Hexcel’s ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, we find that Hexcel’s ROCE is meaningfully better than the 12% average in the Aerospace & Defense industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Hexcel compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

NYSE:HXL Last Perf February 14th 19

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Hexcel’s Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Hexcel has total liabilities of US$327m and total assets of US$2.8b. Therefore its current liabilities are equivalent to approximately 12% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

What We Can Learn From Hexcel’s ROCE

With that in mind, Hexcel’s ROCE appears pretty good. But note: Hexcel may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.