Today we are going to look at Southern Copper Corporation (NYSE:SCCO) 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 up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect 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. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 Southern Copper:
0.24 = US$2.6b ÷ (US$14b – US$1.2b) (Based on the trailing twelve months to September 2018.)
Therefore, Southern Copper has an ROCE of 24%.
Does Southern Copper Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Southern Copper’s ROCE appears to be substantially greater than the 10% 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. Putting aside its position relative to its industry for now, in absolute terms, Southern Copper’s ROCE is currently very good.
As we can see, Southern Copper currently has an ROCE of 24% compared to its ROCE 3 years ago, which was 15%. This makes us think the business might be improving.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. We note Southern Copper could be considered a cyclical business. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Southern Copper.
What Are Current Liabilities, And How Do They Affect Southern Copper’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Southern Copper has total assets of US$14b and current liabilities of US$1.2b. As a result, its current liabilities are equal to approximately 8.4% of its total assets. Minimal current liabilities are not distorting Southern Copper’s impressive ROCE.
The Bottom Line On Southern Copper’s ROCE
This is an attractive combination and suggests the company could have potential. You might be able to find a better buy than Southern Copper. 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).
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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 email@example.com.