Today we are going to look at Zhengye International Holdings Company Limited (HKG:3363) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from 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.'
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 Zhengye International Holdings:
0.17 = CN¥204m ÷ (CN¥2.4b - CN¥1.3b) (Based on the trailing twelve months to June 2019.)
Therefore, Zhengye International Holdings has an ROCE of 17%.
Does Zhengye International Holdings Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Zhengye International Holdings's ROCE appears to be substantially greater than the 13% average in the Packaging industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Zhengye International Holdings's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
We can see that , Zhengye International Holdings currently has an ROCE of 17% compared to its ROCE 3 years ago, which was 13%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how Zhengye International Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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, after all, simply a snap shot of a single year. You can check if Zhengye International Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do Zhengye International Holdings's Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Zhengye International Holdings has total assets of CN¥2.4b and current liabilities of CN¥1.3b. As a result, its current liabilities are equal to approximately 52% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.
The Bottom Line On Zhengye International Holdings's ROCE
The ROCE would not look as appealing if the company had fewer current liabilities. There might be better investments than Zhengye International Holdings out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like Zhengye International Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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