Today we are going to look at China Resources Gas Group Limited (HKG:1193) to see whether it might be an attractive investment prospect. 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. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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?
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 China Resources Gas Group:
0.17 = HK$6.9b ÷ (HK$79b - HK$37b) (Based on the trailing twelve months to June 2019.)
Therefore, China Resources Gas Group has an ROCE of 17%.
Is China Resources Gas Group's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, China Resources Gas Group's ROCE is meaningfully higher than the 9.4% average in the Gas Utilities industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how China Resources Gas Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can see in the image below how China Resources Gas 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. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for China Resources Gas Group.
Do China Resources Gas Group's Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.
China Resources Gas Group has total liabilities of HK$37b and total assets of HK$79b. As a result, its current liabilities are equal to approximately 47% of its total assets. With this level of current liabilities, China Resources Gas Group's ROCE is boosted somewhat.
What We Can Learn From China Resources Gas Group's ROCE
China Resources Gas Group's ROCE does look good, but the level of current liabilities also contribute to that. China Resources Gas Group shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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 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. Thank you for reading.