Why Changfeng Energy Inc.’s (CVE:CFY) Return On Capital Employed Might Be A Concern
Today we are going to look at Changfeng Energy Inc. (CVE:CFY) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is 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. Overall, it is a valuable metric that has its flaws. 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?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Changfeng Energy:
0.11 = CN¥60m ÷ (CN¥667m – CN¥251m) (Based on the trailing twelve months to September 2018.)
Therefore, Changfeng Energy has an ROCE of 11%.
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Is Changfeng Energy’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Changfeng Energy’s ROCE appears to be substantially greater than the 6.6% average in the Gas Utilities industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Changfeng Energy compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Changfeng Energy’s current ROCE of 11% is lower than 3 years ago, when the company reported a 20% ROCE. This makes us wonder if the business is facing new challenges.
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, after all, simply a snap shot of a single year. If Changfeng Energy is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Changfeng Energy’s Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Changfeng Energy has total assets of CN¥667m and current liabilities of CN¥251m. As a result, its current liabilities are equal to approximately 38% of its total assets. Changfeng Energy has a middling amount of current liabilities, increasing its ROCE somewhat.
Our Take On Changfeng Energy’s ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. Of course you might be able to find a better stock than Changfeng Energy. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
