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Should You Like Southern Copper Corporation’s (NYSE:SCCO) High Return On Capital Employed?

Simply Wall St

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Today we'll look at Southern Copper Corporation (NYSE:SCCO) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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 Southern Copper:

0.19 = US$2.8b ÷ (US$16b - US$1.1b) (Based on the trailing twelve months to March 2019.)

Therefore, Southern Copper has an ROCE of 19%.

Check out our latest analysis for Southern Copper

Does Southern Copper Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Southern Copper's ROCE is meaningfully better than the 9.2% average in the Metals and Mining industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Southern Copper sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

In our analysis, Southern Copper's ROCE appears to be 19%, compared to 3 years ago, when its ROCE was 12%. This makes us wonder if the company is improving. The image below shows how Southern Copper's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NYSE:SCCO Past Revenue and Net Income, July 5th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. Given the industry it operates in, Southern Copper could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Southern Copper.

Southern Copper'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.

Southern Copper has total liabilities of US$1.1b and total assets of US$16b. As a result, its current liabilities are equal to approximately 7.2% of its total assets. Low current liabilities have only a minimal impact on Southern Copper's ROCE, making its decent returns more credible.

What We Can Learn From Southern Copper's ROCE

If it is able to keep this up, Southern Copper could be attractive. Southern Copper looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

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.