Shareholders Should Look Hard At Cleanaway Waste Management Limited’s (ASX:CWY) 4.0% Return On Capital
Today we are going to look at Cleanaway Waste Management Limited (ASX:CWY) 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, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE 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 measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.’
How Do You Calculate Return On Capital Employed?
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 Cleanaway Waste Management:
0.04 = AU$145m ÷ (AU$4.0b – AU$422m) (Based on the trailing twelve months to June 2018.)
So, Cleanaway Waste Management has an ROCE of 4.0%.
View our latest analysis for Cleanaway Waste Management
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Does Cleanaway Waste Management Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see Cleanaway Waste Management’s ROCE is meaningfully below the Commercial Services industry average of 13%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Cleanaway Waste Management 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.
As we can see, Cleanaway Waste Management currently has an ROCE of 4.0% compared to its ROCE 3 years ago, which was 3.1%. This makes us think the business might be improving.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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.
How Cleanaway Waste Management’s Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Cleanaway Waste Management has total liabilities of AU$422m and total assets of AU$4.0b. Therefore its current liabilities are equivalent to approximately 10% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
Our Take On Cleanaway Waste Management’s ROCE
That’s not a bad thing, however Cleanaway Waste Management has a weak ROCE and may not be an attractive investment. You might be able to find a better buy than Cleanaway Waste Management. 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).
I will like Cleanaway Waste Management better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
