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Is Innergex Renewable Energy Inc.'s (TSE:INE) Capital Allocation Ability Worth Your Time?

Simply Wall St

Today we'll look at Innergex Renewable Energy Inc. (TSE:INE) 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.

First up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

Understanding 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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

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 Innergex Renewable Energy:

0.042 = CA$226m ÷ (CA$6.3b - CA$893m) (Based on the trailing twelve months to June 2019.)

Therefore, Innergex Renewable Energy has an ROCE of 4.2%.

Check out our latest analysis for Innergex Renewable Energy

Does Innergex Renewable Energy Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, Innergex Renewable Energy's ROCE appears to be around the 4.3% average of the Renewable Energy industry. Independently of how Innergex Renewable Energy compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.9% available in government bonds. There are potentially more appealing investments elsewhere.

You can see in the image below how Innergex Renewable Energy's ROCE compares to its industry. Click to see more on past growth.

TSX:INE Past Revenue and Net Income, October 1st 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Innergex Renewable Energy.

What Are Current Liabilities, And How Do They Affect Innergex Renewable Energy's 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.

Innergex Renewable Energy has total assets of CA$6.3b and current liabilities of CA$893m. As a result, its current liabilities are equal to approximately 14% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.

The Bottom Line On Innergex Renewable Energy's ROCE

While that is good to see, Innergex Renewable Energy has a low ROCE and does not look attractive in this analysis. Of course, you might also be able to find a better stock than Innergex Renewable Energy. So you may wish to see this free collection of other companies that have grown earnings strongly.

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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.