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Why K2 F&B Holdings Limited’s (HKG:2108) Return On Capital Employed Might Be A Concern

Simply Wall St

Today we'll evaluate K2 F&B Holdings Limited (HKG:2108) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its 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.

So, How Do We Calculate ROCE?

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 K2 F&B Holdings:

0.037 = S$4.4m ÷ (S$125m - S$8.1m) (Based on the trailing twelve months to June 2019.)

So, K2 F&B Holdings has an ROCE of 3.7%.

See our latest analysis for K2 F&B Holdings

Is K2 F&B Holdings's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. We can see K2 F&B Holdings's ROCE is meaningfully below the Hospitality industry average of 5.1%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how K2 F&B Holdings stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.

K2 F&B Holdings's current ROCE of 3.7% is lower than its ROCE in the past, which was 5.8%, 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how K2 F&B Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.

SEHK:2108 Past Revenue and Net Income, November 19th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. How cyclical is K2 F&B Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Do K2 F&B Holdings'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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

K2 F&B Holdings has total liabilities of S$8.1m and total assets of S$125m. As a result, its current liabilities are equal to approximately 6.5% of its total assets. K2 F&B Holdings has a low level of current liabilities, which have a negligible impact on its already low ROCE.

Our Take On K2 F&B Holdings's ROCE

Nevertheless, there are potentially more attractive companies to invest in. Of course, you might also be able to find a better stock than K2 F&B Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

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 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.