Today we'll look at Mineral Resources Limited (ASX:MIN) and reflect on its potential as an investment. 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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?
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 Mineral Resources:
0.12 = AU$325m ÷ (AU$3.2b - AU$425m) (Based on the trailing twelve months to June 2019.)
So, Mineral Resources has an ROCE of 12%.
Is Mineral Resources's ROCE Good?
One way to assess ROCE is to compare similar companies. Mineral Resources's ROCE appears to be substantially greater than the 8.0% average in the Metals and Mining industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Mineral Resources's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Mineral Resources has an ROCE of 12%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability. You can see in the image below how Mineral Resources'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. ROCE is, after all, simply a snap shot of a single year. We note Mineral Resources 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 Mineral Resources.
How Mineral Resources's Current Liabilities Impact Its 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Mineral Resources has total assets of AU$3.2b and current liabilities of AU$425m. As a result, its current liabilities are equal to approximately 13% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On Mineral Resources's ROCE
This is good to see, and with a sound ROCE, Mineral Resources could be worth a closer look. There might be better investments than Mineral Resources 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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