Today we'll evaluate Ternium S.A. (NYSE:TX) to determine whether it could have potential as an investment idea. 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 of all, we'll work out how to 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 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) (Total Assets - Current Liabilities)
Or for Ternium:
0.14 = US$1.6b (US$14b - US$2.1b) (Based on the trailing twelve months to June 2019.)
So, Ternium has an ROCE of 14%.
Is Ternium's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Ternium's ROCE appears to be substantially greater than the 8.9% average in the Metals and Mining 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. Separate from Ternium's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can see in the image below how Ternium's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, Ternium could be considered cyclical. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Ternium.
Do Ternium'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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Ternium has total assets of US$14b and current liabilities of US$2.1b. Therefore its current liabilities are equivalent to approximately 16% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On Ternium's ROCE
This is good to see, and with a sound ROCE, Ternium could be worth a closer look. Ternium shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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. Thank you for reading.