Today we'll evaluate Transurban Group (ASX:TCL) to determine whether it could have potential as an investment idea. 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. Then we'll compare its ROCE 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. 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 Transurban Group:
0.033 = AU$1.0b ÷ (AU$36b - AU$4.7b) (Based on the trailing twelve months to December 2019.)
So, Transurban Group has an ROCE of 3.3%.
Does Transurban Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Transurban Group's ROCE is meaningfully below the Infrastructure industry average of 4.3%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Transurban Group compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.1% available in government bonds. There are potentially more appealing investments elsewhere.
You can see in the image below how Transurban Group's ROCE compares to its industry. Click to see more on past growth.
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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Transurban Group.
Transurban Group'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 counter this, investors can check if a company has high current liabilities relative to total assets.
Transurban Group has current liabilities of AU$4.7b and total assets of AU$36b. As a result, its current liabilities are equal to approximately 13% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
The Bottom Line On Transurban Group's ROCE
Transurban Group has a poor ROCE, and there may be better investment prospects out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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If you spot an error that warrants correction, please contact the editor at email@example.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.
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