In This Article:
Today we’ll evaluate K.M. Sugar Mills Limited (NSE:KMSUGAR) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
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.
Understanding Return On Capital Employed (ROCE)
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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
How Do You Calculate Return On Capital Employed?
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 K.M. Sugar Mills:
0.056 = ₹58m ÷ (₹2.1b – ₹1.1b) (Based on the trailing twelve months to September 2018.)
So, K.M. Sugar Mills has an ROCE of 5.6%.
Check out our latest analysis for K.M. Sugar Mills
Does K.M. Sugar Mills Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see K.M. Sugar Mills’s ROCE is meaningfully below the Food industry average of 14%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how K.M. Sugar Mills compares to its industry, its ROCE in absolute terms is low; especially compared to the ~7.6% available in government bonds. It is likely that there are more attractive prospects out there.
As we can see, K.M. Sugar Mills currently has an ROCE of 5.6%, less than the 20% it reported 3 years ago. This makes us wonder if the business is facing new challenges.
It is important to remember that ROCE shows past performance, and is 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. If K.M. Sugar Mills is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do K.M. Sugar Mills’s Current Liabilities Skew 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 counter this, investors can check if a company has high current liabilities relative to total assets.