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Should You Like Ternium S.A.’s (NYSE:TX) High Return On Capital Employed?

Ray Foley

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Today we’ll look at Ternium S.A. (NYSE:TX) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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’.

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 Ternium:

0.20 = US$1.5b ÷ (US$12b – US$2.3b) (Based on the trailing twelve months to September 2018.)

So, Ternium has an ROCE of 20%.

See our latest analysis for Ternium

Does Ternium Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Ternium’s ROCE appears to be substantially greater than the 11% average in the Metals and Mining industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Ternium compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Our data shows that Ternium currently has an ROCE of 20%, compared to its ROCE of 8.4% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.

NYSE:TX Last Perf February 11th 19

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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 only a point-in-time measure. Remember that most companies like Ternium are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for Ternium.

Ternium’s Current Liabilities And Their Impact On Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Ternium has total assets of US$12b and current liabilities of US$2.3b. As a result, its current liabilities are equal to approximately 19% of its total assets. Low current liabilities are not boosting the ROCE too much.

Our Take On Ternium’s ROCE

This is good to see, and with a sound ROCE, Ternium could be worth a closer look. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

I will like Ternium 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.