Today we'll evaluate Methanex Corporation (TSE:MX) 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.
First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect 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. In general, businesses with a higher ROCE are usually better quality. 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?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Methanex:
0.026 = US$130m ÷ (US$5.7b - US$736m) (Based on the trailing twelve months to March 2020.)
So, Methanex has an ROCE of 2.6%.
Is Methanex's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see Methanex's ROCE is meaningfully below the Chemicals industry average of 5.4%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Methanex compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.7% available in government bonds. Readers may wish to look for more rewarding investments.
Methanex's current ROCE of 2.6% is lower than 3 years ago, when the company reported a 5.3% ROCE. So investors might consider if it has had issues recently. The image below shows how Methanex's ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. 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 Methanex.
Methanex's Current Liabilities And Their Impact On 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Methanex has total assets of US$5.7b and current liabilities of US$736m. As a result, its current liabilities are equal to approximately 13% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
The Bottom Line On Methanex's ROCE
Methanex has a poor ROCE, and there may be better investment prospects out there. Of course, you might also be able to find a better stock than Methanex. So you may wish to see this free collection of other companies that have grown earnings strongly.
Methanex is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider buying.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.