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Why Outokumpu Oyj’s (HEL:OUT1V) Use Of Investor Capital Doesn’t Look Great

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Today we'll look at Outokumpu Oyj (HEL:OUT1V) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

Firstly, we'll go over how we 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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 Outokumpu Oyj:

0.022 = €85m ÷ (€6.2b - €2.4b) (Based on the trailing twelve months to June 2019.)

Therefore, Outokumpu Oyj has an ROCE of 2.2%.

View our latest analysis for Outokumpu Oyj

Is Outokumpu Oyj's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. We can see Outokumpu Oyj's ROCE is meaningfully below the Metals and Mining industry average of 9.4%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Outokumpu Oyj compares to its industry, its ROCE in absolute terms is low; especially compared to the ~0.5% available in government bonds. Readers may wish to look for more rewarding investments.

Outokumpu Oyj delivered an ROCE of 2.2%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving. You can see in the image below how Outokumpu Oyj's ROCE compares to its industry. Click to see more on past growth.

HLSE:OUT1V Past Revenue and Net Income, August 27th 2019
HLSE:OUT1V Past Revenue and Net Income, August 27th 2019

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. ROCE is only a point-in-time measure. We note Outokumpu Oyj could be considered a cyclical business. Since the future is so important for investors, you should check out our free report on analyst forecasts for Outokumpu Oyj.

What Are Current Liabilities, And How Do They Affect Outokumpu Oyj'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 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.

Outokumpu Oyj has total assets of €6.2b and current liabilities of €2.4b. Therefore its current liabilities are equivalent to approximately 39% of its total assets. With a medium level of current liabilities boosting the ROCE a little, Outokumpu Oyj's low ROCE is unappealing.

Our Take On Outokumpu Oyj's ROCE

This company may not be the most attractive investment prospect. You might be able to find a better investment than Outokumpu Oyj. 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).

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.