Today we'll evaluate OZ Minerals Limited (ASX:OZL) 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. 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. Overall, it is a valuable metric that has its flaws. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
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 OZ Minerals:
0.059 = AU$197m ÷ (AU$3.6b - AU$222m) (Based on the trailing twelve months to June 2019.)
Therefore, OZ Minerals has an ROCE of 5.9%.
Does OZ Minerals Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see OZ Minerals's ROCE is meaningfully below the Metals and Mining industry average of 8.0%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how OZ Minerals stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
You can see in the image below how OZ Minerals's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. Given the industry it operates in, OZ Minerals could be considered cyclical. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for OZ Minerals.
How OZ Minerals's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
OZ Minerals has total assets of AU$3.6b and current liabilities of AU$222m. As a result, its current liabilities are equal to approximately 6.2% of its total assets. OZ Minerals has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
Our Take On OZ Minerals's ROCE
OZ Minerals 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 OZ Minerals. 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).
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.
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. Thank you for reading.