Today we are going to look at Mercer International Inc. (NASDAQ:MERC) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, 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.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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.’
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 Mercer International:
0.18 = US$168m ÷ (US$1.5b – US$175m) (Based on the trailing twelve months to September 2018.)
Therefore, Mercer International has an ROCE of 18%.
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Is Mercer International’s ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that Mercer International’s ROCE is meaningfully better than the 9.8% average in the Forestry industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Mercer International compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
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, 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 Mercer International.
What Are Current Liabilities, And How Do They Affect Mercer International’s ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.
Mercer International has total liabilities of US$175m and total assets of US$1.5b. Therefore its current liabilities are equivalent to approximately 11% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Mercer International’s ROCE
With that in mind, Mercer International’s ROCE appears pretty good. Of course you might be able to find a better stock than Mercer International. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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 email@example.com.