Why Orient Cement Limited's (NSE:ORIENTCEM) Return On Capital Employed Might Be A Concern




  • In Business
  • 2019-05-16 07:07:03Z
  • By Simply Wall St.
 

Today we'll look at Orient Cement Limited (NSE:ORIENTCEM) and reflect on its potential as an investment. 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, we'll go over how we calculate ROCE. 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Orient Cement:

0.074 = ₹1.8b ÷ (₹29b - ₹5.1b) (Based on the trailing twelve months to March 2019.)

So, Orient Cement has an ROCE of 7.4%.

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See our latest analysis for Orient Cement

Is Orient Cement's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Orient Cement's ROCE appears to be significantly below the 9.8% average in the Basic Materials industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside Orient Cement's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.

In our analysis, Orient Cement's ROCE appears to be 7.4%, compared to 3 years ago, when its ROCE was 4.4%. This makes us wonder if the company is improving.

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. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Orient Cement.

How Orient Cement's Current Liabilities Impact 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Orient Cement has total assets of ₹29b and current liabilities of ₹5.1b. Therefore its current liabilities are equivalent to approximately 17% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

What We Can Learn From Orient Cement's ROCE

That's not a bad thing, however Orient Cement has a weak ROCE and may not be an attractive investment. Of course, you might also be able to find a better stock than Orient Cement. So you may wish to see this free collection of other companies that have grown earnings strongly.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.

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