Examining Inner Mongolia Energy Engineering Co., Ltd.’s (HKG:1649) Weak Return On Capital Employed
Today we are going to look at Inner Mongolia Energy Engineering Co., Ltd. (HKG:1649) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect 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. In brief, it is a useful tool, but it is not without drawbacks. 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’.
How Do You Calculate Return On Capital Employed?
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 Inner Mongolia Energy Engineering:
0.07 = CN¥681m ÷ (CN¥17b – CN¥9.3b) (Based on the trailing twelve months to June 2018.)
Therefore, Inner Mongolia Energy Engineering has an ROCE of 7.0%.
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Does Inner Mongolia Energy Engineering Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In this analysis, Inner Mongolia Energy Engineering’s ROCE appears meaningfully below the 14% average reported by the Construction industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Inner Mongolia Energy Engineering 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.
As we can see, Inner Mongolia Energy Engineering currently has an ROCE of 7.0%, less than the 10% it reported 3 years ago. This makes us wonder if the business is facing new challenges.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Inner Mongolia Energy Engineering? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Inner Mongolia Energy Engineering’s ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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.
Inner Mongolia Energy Engineering has total liabilities of CN¥9.3b and total assets of CN¥17b. Therefore its current liabilities are equivalent to approximately 55% of its total assets. With a high level of current liabilities, Inner Mongolia Energy Engineering will experience a boost to its ROCE.
What We Can Learn From Inner Mongolia Energy Engineering’s ROCE
Notably, it also has a mediocre ROCE, which to my mind is not an appealing combination. Of course you might be able to find a better stock than Inner Mongolia Energy Engineering. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
