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Are Russel Metals Inc.’s (TSE:RUS) High Returns Really That Great?

Simply Wall St

Today we’ll evaluate Russel Metals Inc. (TSE:RUS) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.

What is 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. Generally speaking a higher ROCE is better. 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?

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 Russel Metals:

0.23 = CA$335m ÷ (CA$2.1b – CA$645m) (Based on the trailing twelve months to December 2018.)

Therefore, Russel Metals has an ROCE of 23%.

Check out our latest analysis for Russel Metals

Does Russel Metals Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, we find that Russel Metals’s ROCE is meaningfully better than the 17% average in the Trade Distributors industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Setting aside the comparison to its industry for a moment, Russel Metals’s ROCE in absolute terms currently looks quite high.

In our analysis, Russel Metals’s ROCE appears to be 23%, compared to 3 years ago, when its ROCE was 4.8%. This makes us think about whether the company has been reinvesting shrewdly.

TSX:RUS Past Revenue and Net Income, February 28th 2019

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Russel Metals’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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Russel Metals has total assets of CA$2.1b and current liabilities of CA$645m. As a result, its current liabilities are equal to approximately 30% of its total assets. Russel Metals’s ROCE is boosted somewhat by its middling amount of current liabilities.

Our Take On Russel Metals’s ROCE

Even so, it has a great ROCE, and could be an attractive prospect for further research. Of course you might be able to find a better stock than Russel Metals. 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 editorial-team@simplywallst.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.