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Why You Should Care About Cascades Inc.’s (TSE:CAS) Low Return On Capital

Simply Wall St

Today we'll look at Cascades Inc. (TSE:CAS) 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. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

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

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 Cascades:

0.059 = CA$237m ÷ (CA$5.0b - CA$1.0b) (Based on the trailing twelve months to June 2019.)

Therefore, Cascades has an ROCE of 5.9%.

Check out our latest analysis for Cascades

Is Cascades's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Cascades's ROCE appears meaningfully below the 9.8% average reported by the Packaging industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Cascades stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

We can see that , Cascades currently has an ROCE of 5.9%, less than the 8.1% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Cascades's past growth compares to other companies.

TSX:CAS Past Revenue and Net Income, August 13th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Cascades'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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Cascades has total liabilities of CA$1.0b and total assets of CA$5.0b. Therefore its current liabilities are equivalent to approximately 20% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

Our Take On Cascades's ROCE

With that in mind, we're not overly impressed with Cascades's ROCE, so it may not be the most appealing prospect. 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.

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.