Today we'll look at Kenmare Resources plc (LON:KMR) and reflect on its potential as an investment. 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. 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.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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 Kenmare Resources:
0.059 = US$56m ÷ (US$1.0b - US$53m) (Based on the trailing twelve months to June 2019.)
So, Kenmare Resources has an ROCE of 5.9%.
Is Kenmare Resources's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Kenmare Resources's ROCE appears to be significantly below the 13% average in the Metals and Mining industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, Kenmare Resources's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
Kenmare Resources has an ROCE of 5.9%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability. You can see in the image below how Kenmare Resources's ROCE compares to its industry. Click to see more on 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, after all, simply a snap shot of a single year. Given the industry it operates in, Kenmare Resources could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Kenmare Resources.
How Kenmare Resources's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Kenmare Resources has total assets of US$1.0b and current liabilities of US$53m. Therefore its current liabilities are equivalent to approximately 5.2% of its total assets. Kenmare Resources has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
The Bottom Line On Kenmare Resources's ROCE
Kenmare Resources looks like an ok business, but on this analysis it is not at the top of our buy list. You might be able to find a better investment than Kenmare Resources. 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).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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