Today we are going to look at Adani Transmissions Limited (NSE:ADANITRANS) to see whether it might be an attractive investment prospect. 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.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
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 Adani Transmissions:
0.10 = ₹28b ÷ (₹336b - ₹56b) (Based on the trailing twelve months to September 2019.)
Therefore, Adani Transmissions has an ROCE of 10.0%.
Does Adani Transmissions Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Adani Transmissions's ROCE appears to be around the 9.9% average of the Electric Utilities industry. Regardless of how Adani Transmissions stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
Adani Transmissions's current ROCE of 10.0% is lower than its ROCE in the past, which was 14%, 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Adani Transmissions'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 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.
Do Adani Transmissions's Current Liabilities Skew 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Adani Transmissions has total assets of ₹336b and current liabilities of ₹56b. Therefore its current liabilities are equivalent to approximately 17% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
The Bottom Line On Adani Transmissions's ROCE
Adani Transmissions has a poor ROCE, and there may be better investment prospects out there. Of course, you might also be able to find a better stock than Adani Transmissions. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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.