Today we'll look at Kothari Sugars and Chemicals Limited (NSE:KOTARISUG) and reflect on its potential as an investment. 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on 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. 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.'
So, How Do We Calculate ROCE?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Kothari Sugars and Chemicals:
0.079 = ₹172m ÷ (₹3.9b - ₹1.8b) (Based on the trailing twelve months to March 2019.)
So, Kothari Sugars and Chemicals has an ROCE of 7.9%.
Does Kothari Sugars and Chemicals Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Kothari Sugars and Chemicals's ROCE appears meaningfully below the 12% average reported by the Food industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Kothari Sugars and Chemicals 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.
We can see that , Kothari Sugars and Chemicals currently has an ROCE of 7.9% compared to its ROCE 3 years ago, which was 1.2%. This makes us wonder if the company is improving. You can see in the image below how Kothari Sugars and Chemicals's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. You can check if Kothari Sugars and Chemicals has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do Kothari Sugars and Chemicals'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 counter this, investors can check if a company has high current liabilities relative to total assets.
Kothari Sugars and Chemicals has total assets of ₹3.9b and current liabilities of ₹1.8b. Therefore its current liabilities are equivalent to approximately 45% of its total assets. Kothari Sugars and Chemicals has a medium level of current liabilities (boosting the ROCE somewhat), and a low ROCE.
Our Take On Kothari Sugars and Chemicals's ROCE
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