Today we’ll evaluate LyondellBasell Industries N.V. (NYSE:LYB) to determine whether it could have potential as an investment idea. 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, we’ll go over how we calculate ROCE. 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.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. 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 LyondellBasell Industries:
0.23 = US$5.3b ÷ (US$28b – US$5.5b) (Based on the trailing twelve months to December 2018.)
Therefore, LyondellBasell Industries has an ROCE of 23%.
Does LyondellBasell Industries Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, LyondellBasell Industries’s ROCE is meaningfully higher than the 12% average in the Chemicals industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of the industry comparison, in absolute terms, LyondellBasell Industries’s ROCE currently appears to be excellent.
LyondellBasell Industries’s current ROCE of 23% is lower than its ROCE in the past, which was 33%, 3 years ago. 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for LyondellBasell Industries.
What Are Current Liabilities, And How Do They Affect LyondellBasell Industries’s 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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
LyondellBasell Industries has total assets of US$28b and current liabilities of US$5.5b. As a result, its current liabilities are equal to approximately 19% of its total assets. The fairly low level of current liabilities won’t have much impact on the already great ROCE.
What We Can Learn From LyondellBasell Industries’s ROCE
Low current liabilities and high ROCE is a good combination, making LyondellBasell Industries look quite interesting. 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.