Today we'll look at IL&FS Transportation Networks Limited (NSE:IL&FSTRANS) and reflect on its potential as an investment. 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.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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'.
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 IL&FS Transportation Networks:
0.084 = ₹29b ÷ (₹472b - ₹131b) (Based on the trailing twelve months to March 2018.)
Therefore, IL&FS Transportation Networks has an ROCE of 8.4%.
Is IL&FS Transportation Networks's ROCE Good?
One way to assess ROCE is to compare similar companies. IL&FS Transportation Networks's ROCE appears to be substantially greater than the 5.9% average in the Infrastructure industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of how IL&FS Transportation Networks stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
You can click on the image below to see (in greater detail) how IL&FS Transportation Networks's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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 only a point-in-time measure. If IL&FS Transportation Networks is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do IL&FS Transportation Networks'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 counter this, investors can check if a company has high current liabilities relative to total assets.
IL&FS Transportation Networks has total assets of ₹472b and current liabilities of ₹131b. As a result, its current liabilities are equal to approximately 28% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
Our Take On IL&FS Transportation Networks's ROCE
IL&FS Transportation Networks has a poor ROCE, and there may be better investment prospects out there. You might be able to find a better investment than IL&FS Transportation Networks. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like IL&FS Transportation Networks better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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If you spot an error that warrants correction, please contact the editor at email@example.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.