Today we'll evaluate Modine Manufacturing Company (NYSE:MOD) to determine whether it could have potential as an investment idea. 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. 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 'return' (pre-tax profit) a company generates from 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.
How Do You Calculate Return On Capital Employed?
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 Modine Manufacturing:
0.099 = US$103m ÷ (US$1.6b - US$558m) (Based on the trailing twelve months to June 2019.)
So, Modine Manufacturing has an ROCE of 9.9%.
Does Modine Manufacturing Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Modine Manufacturing's ROCE appears to be significantly below the 15% average in the Auto Components industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Modine Manufacturing stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
We can see that, Modine Manufacturing currently has an ROCE of 9.9% compared to its ROCE 3 years ago, which was 3.9%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Modine Manufacturing's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Modine Manufacturing's Current Liabilities And Their Impact On Its 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 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.
Modine Manufacturing has total liabilities of US$558m and total assets of US$1.6b. Therefore its current liabilities are equivalent to approximately 35% of its total assets. Modine Manufacturing has a medium level of current liabilities, which would boost its ROCE somewhat.
The Bottom Line On Modine Manufacturing's ROCE
Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. You might be able to find a better investment than Modine Manufacturing. 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 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.