Today we'll look at K+S Aktiengesellschaft (ETR:SDF) 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
What is 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. 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 K+S:
0.03 = €273m ÷ (€10b - €1.1b) (Based on the trailing twelve months to June 2019.)
Therefore, K+S has an ROCE of 3.0%.
Does K+S Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see K+S's ROCE is meaningfully below the Chemicals industry average of 8.1%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside K+S'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.
K+S's current ROCE of 3.0% is lower than 3 years ago, when the company reported a 6.3% ROCE. Therefore we wonder if the company is facing new headwinds. The image below shows how K+S's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for K+S.
How K+S's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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+S has total liabilities of €1.1b and total assets of €10b. Therefore its current liabilities are equivalent to approximately 11% 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 K+S's ROCE
While that is good to see, K+S has a low ROCE and does not look attractive in this analysis. You might be able to find a better investment than K+S. 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).
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 firstname.lastname@example.org. 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.