Today we’ll look at SP Corporation Limited (SGX:AWE) and reflect on its potential as an investment. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting 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. Generally speaking a higher ROCE is better. 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’.
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 SP:
0.013 = S$684k ÷ (S$68m – S$14m) (Based on the trailing twelve months to December 2018.)
So, SP has an ROCE of 1.3%.
See our latest analysis for SP
Does SP Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see SP’s ROCE is meaningfully below the Trade Distributors industry average of 3.1%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how SP compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.3% available in government bonds. There are potentially more appealing investments elsewhere.
As we can see, SP currently has an ROCE of 1.3% compared to its ROCE 3 years ago, which was 0.7%. 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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. How cyclical is SP? 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 SP’s 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 counter this, investors can check if a company has high current liabilities relative to total assets.