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Don’t Buy Eastman Kodak Company (NYSE:KODK) Until You Understand Its ROCE

Andrew Edmonds

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Today we are going to look at Eastman Kodak Company (NYSE:KODK) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. 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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’

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 Eastman Kodak:

0.12 = US$104m ÷ (US$1.5b – US$779m) (Based on the trailing twelve months to September 2018.)

Therefore, Eastman Kodak has an ROCE of 12%.

See our latest analysis for Eastman Kodak

Is Eastman Kodak’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. It appears that Eastman Kodak’s ROCE is fairly close to the Tech industry average of 12%. Regardless of where Eastman Kodak sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Our data shows that Eastman Kodak currently has an ROCE of 12%, compared to its ROCE of 4.7% 3 years ago. This makes us wonder if the company is improving.

NYSE:KODK Last Perf February 1st 19

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Eastman Kodak? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Eastman Kodak’s Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Eastman Kodak has total assets of US$1.5b and current liabilities of US$779m. As a result, its current liabilities are equal to approximately 51% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.

What We Can Learn From Eastman Kodak’s ROCE

The ROCE would not look as appealing if the company had fewer current liabilities. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.