Why K-Bro Linen Inc.’s (TSE:KBL) Return On Capital Employed Might Be A Concern
Today we'll evaluate K-Bro Linen Inc. (TSE:KBL) to determine whether it could have potential as an investment idea. 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.
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. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 K-Bro Linen:
0.037 = CA$11m ÷ (CA$322m - CA$36m) (Based on the trailing twelve months to December 2018.)
Therefore, K-Bro Linen has an ROCE of 3.7%.
Check out our latest analysis for K-Bro Linen
Does K-Bro Linen Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, K-Bro Linen's ROCE appears meaningfully below the 9.7% average reported by the Commercial Services industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how K-Bro Linen stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
K-Bro Linen's current ROCE of 3.7% is lower than its ROCE in the past, which was 14%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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 K-Bro Linen.
K-Bro Linen'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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
K-Bro Linen has total liabilities of CA$36m and total assets of CA$322m. Therefore its current liabilities are equivalent to approximately 11% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
What We Can Learn From K-Bro Linen's ROCE
K-Bro Linen has a poor ROCE, and there may be better investment prospects out there. 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.
I will like K-Bro Linen better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 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.
