Today we are going to look at Public Joint Stock Company Kurgan Generation Company (MCX:KGKC) to see whether it might be an attractive investment prospect. 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. Second, we'll look at its ROCE compared to similar companies. 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?
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 Kurgan Generation:
0.10 = ₽848m ÷ (₽11b - ₽2.2b) (Based on the trailing twelve months to June 2019.)
So, Kurgan Generation has an ROCE of 10%.
Does Kurgan Generation Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Kurgan Generation's ROCE is meaningfully higher than the 5.7% average in the Water Utilities industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of how Kurgan Generation 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.
In our analysis, Kurgan Generation's ROCE appears to be 10%, compared to 3 years ago, when its ROCE was 3.8%. This makes us think the business might be improving. The image below shows how Kurgan Generation'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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Kurgan Generation is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Kurgan Generation'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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Kurgan Generation has current liabilities of ₽2.2b and total assets of ₽11b. As a result, its current liabilities are equal to approximately 20% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
Our Take On Kurgan Generation's ROCE
Kurgan Generation has a poor ROCE, and there may be better investment prospects out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.