Why The Straits Trading Company Limited’s (SGX:S20) Return On Capital Employed Looks Uninspiring

Simply Wall St

Sun, Apr 7, 2019, 7:10 PM

Today we'll look at The Straits Trading Company Limited (SGX:S20) 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. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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?

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 Straits Trading:

0.036 = S$81m ÷ (S$2.6b - S$331m) (Based on the trailing twelve months to December 2018.)

Therefore, Straits Trading has an ROCE of 3.6%.

See our latest analysis for Straits Trading

Is Straits Trading's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Straits Trading's ROCE appears meaningfully below the 15% average reported by the Metals and Mining industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Straits Trading stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.

As we can see, Straits Trading currently has an ROCE of 3.6% compared to its ROCE 3 years ago, which was 1.2%. This makes us think the business might be improving.

SGX:S20 Past Revenue and Net Income, April 8th 2019

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, Straits Trading could be considered cyclical. You can check if Straits Trading has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.