Today we are going to look at Fresnillo Plc (LON:FRES) 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
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. 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 Fresnillo:
0.051 = US$229m ÷ (US$4.7b - US$156m) (Based on the trailing twelve months to June 2019.)
Therefore, Fresnillo has an ROCE of 5.1%.
Is Fresnillo's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Fresnillo's ROCE is meaningfully below the Metals and Mining industry average of 12%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Fresnillo stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
Fresnillo's current ROCE of 5.1% is lower than 3 years ago, when the company reported a 12% ROCE. So investors might consider if it has had issues recently. You can see in the image below how Fresnillo's ROCE compares to its industry. Click to see more on past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, Fresnillo could be considered cyclical. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Fresnillo's 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Fresnillo has total assets of US$4.7b and current liabilities of US$156m. Therefore its current liabilities are equivalent to approximately 3.3% of its total assets. Fresnillo has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
The Bottom Line On Fresnillo's ROCE
Fresnillo looks like an ok business, but on this analysis it is not at the top of our buy list. You might be able to find a better investment than Fresnillo. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
There are plenty of other companies that have insiders buying up shares. You probably do 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 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.