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Why You Should Care About Som Distilleries & Breweries Limited’s (NSE:SDBL) Low Return On Capital

Simply Wall St

Today we'll look at Som Distilleries & Breweries Limited (NSE:SDBL) 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on 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. 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 Som Distilleries & Breweries:

0.12 = ₹500m ÷ (₹6.9b - ₹2.6b) (Based on the trailing twelve months to June 2019.)

So, Som Distilleries & Breweries has an ROCE of 12%.

View our latest analysis for Som Distilleries & Breweries

Does Som Distilleries & Breweries Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Som Distilleries & Breweries's ROCE appears meaningfully below the 16% average reported by the Beverage industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Som Distilleries & Breweries 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.

Som Distilleries & Breweries's current ROCE of 12% is lower than its ROCE in the past, which was 18%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Som Distilleries & Breweries's past growth compares to other companies.

NSEI:SDBL Past Revenue and Net Income, September 30th 2019
NSEI:SDBL Past Revenue and Net Income, September 30th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. If Som Distilleries & Breweries is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Som Distilleries & Breweries'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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Som Distilleries & Breweries has total assets of ₹6.9b and current liabilities of ₹2.6b. Therefore its current liabilities are equivalent to approximately 38% of its total assets. Som Distilleries & Breweries's ROCE is improved somewhat by its moderate amount of current liabilities.

What We Can Learn From Som Distilleries & Breweries's ROCE

Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. You might be able to find a better investment than Som Distilleries & Breweries. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.