Today we’ll look at CF Industries Holdings, Inc. (NYSE:CF) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of 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.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 CF Industries Holdings:
0.06 = US$723m ÷ (US$13b – US$705m) (Based on the trailing twelve months to December 2018.)
Therefore, CF Industries Holdings has an ROCE of 6.0%.
Does CF Industries Holdings Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see CF Industries Holdings’s ROCE is meaningfully below the Chemicals industry average of 12%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Setting aside the industry comparison for now, CF Industries Holdings’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
CF Industries Holdings’s current ROCE of 6.0% is lower than 3 years ago, when the company reported a 11% ROCE. So investors might consider if it has had issues recently.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 CF Industries Holdings.
How CF Industries Holdings’s Current Liabilities Impact Its 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 counter this, investors can check if a company has high current liabilities relative to total assets.
CF Industries Holdings has total assets of US$13b and current liabilities of US$705m. As a result, its current liabilities are equal to approximately 5.6% of its total assets. CF Industries Holdings reports few current liabilities, which have a negligible impact on its unremarkable ROCE.
Our Take On CF Industries Holdings’s ROCE
CF Industries Holdings looks like an ok business, but on this analysis it is not at the top of our buy list. But note: CF Industries Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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.