Today we are going to look at Rashtriya Chemicals and Fertilizers Limited (NSE:RCF) 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
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.'
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 Rashtriya Chemicals and Fertilizers:
0.088 = ₹3.7b ÷ (₹89b - ₹47b) (Based on the trailing twelve months to June 2019.)
So, Rashtriya Chemicals and Fertilizers has an ROCE of 8.8%.
Is Rashtriya Chemicals and Fertilizers's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Rashtriya Chemicals and Fertilizers's ROCE appears to be significantly below the 17% average in the Chemicals 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 Rashtriya Chemicals and Fertilizers 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.
The image below shows how Rashtriya Chemicals and Fertilizers'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. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Rashtriya Chemicals and Fertilizers is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Rashtriya Chemicals and Fertilizers'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.
Rashtriya Chemicals and Fertilizers has total assets of ₹89b and current liabilities of ₹47b. Therefore its current liabilities are equivalent to approximately 53% of its total assets. This is a fairly high level of current liabilities, boosting Rashtriya Chemicals and Fertilizers's ROCE.
Our Take On Rashtriya Chemicals and Fertilizers's ROCE
Rashtriya Chemicals and Fertilizers's ROCE in absolute terms is poor, and there are likely better investment prospects out there. Of course, you might also be able to find a better stock than Rashtriya Chemicals and Fertilizers. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 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.