Today we are going to look at CK Hutchison Holdings Limited (HKG:1) 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 of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
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. Overall, it is a valuable metric that has its flaws. 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 CK Hutchison Holdings:
0.049 = HK$51b ÷ (HK$1.3t – HK$233b) (Based on the trailing twelve months to June 2019.)
Therefore, CK Hutchison Holdings has an ROCE of 4.9%.
Is CK Hutchison Holdings’s ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, CK Hutchison Holdings’s ROCE is meaningfully higher than the 3.7% average in the Industrials 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 how CK Hutchison Holdings stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for CK Hutchison Holdings.
CK Hutchison Holdings’s Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
CK Hutchison Holdings has total liabilities of HK$233b and total assets of HK$1.3t. Therefore its current liabilities are equivalent to approximately 18% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
What We Can Learn From CK Hutchison Holdings’s ROCE
That’s not a bad thing, however CK Hutchison Holdings has a weak ROCE and may not be an attractive investment. You might be able to find a better investment than CK Hutchison Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.