Yahoo Finance Here’s What Centrica plc’s (LON:CNA) ROCE Can Tell Us
Today we’ll evaluate Centrica plc (LON:CNA) to determine whether it could have potential as an investment idea. 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 of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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’.
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 Centrica:
0.13 = UK£1.5b ÷ (UK£21b – UK£8.4b) (Based on the trailing twelve months to December 2018.)
So, Centrica has an ROCE of 13%.
Check out our latest analysis for Centrica
Is Centrica’s ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, Centrica’s ROCE is meaningfully higher than the 6.5% average in the Integrated Utilities industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where Centrica sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
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, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Centrica’s Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Centrica has total liabilities of UK£8.4b and total assets of UK£21b. Therefore its current liabilities are equivalent to approximately 41% of its total assets. With this level of current liabilities, Centrica’s ROCE is boosted somewhat.
The Bottom Line On Centrica’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. Of course you might be able to find a better stock than Centrica. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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.
