Today we are going to look at Panama Petrochem Limited (NSE:PANAMAPET) to see whether it might be an attractive investment prospect. 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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.'
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 Panama Petrochem:
0.21 = ₹904m ÷ (₹9.2b - ₹5.0b) (Based on the trailing twelve months to June 2019.)
Therefore, Panama Petrochem has an ROCE of 21%.
Is Panama Petrochem's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Panama Petrochem's ROCE is meaningfully better than the 17% average in the Chemicals industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Panama Petrochem sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
You can click on the image below to see (in greater detail) how Panama Petrochem's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Panama Petrochem is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Panama Petrochem's Current Liabilities And Their Impact On Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Panama Petrochem has total liabilities of ₹5.0b and total assets of ₹9.2b. As a result, its current liabilities are equal to approximately 54% of its total assets. Panama Petrochem's current liabilities are fairly high, which increases its ROCE significantly.
Our Take On Panama Petrochem's ROCE
The ROCE would not look as appealing if the company had fewer current liabilities. Panama Petrochem looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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 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.