Today we are going to look at Axalta Coating Systems Ltd. (NYSE:AXTA) to see whether it might be an attractive investment prospect. 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.
Firstly, we’ll go over how we calculate ROCE. 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from 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. 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’.
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 Axalta Coating Systems:
0.10 = US$569m ÷ (US$6.7b – US$1.0b) (Based on the trailing twelve months to September 2019.)
So, Axalta Coating Systems has an ROCE of 10%.
Does Axalta Coating Systems Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Axalta Coating Systems’s ROCE is around the 9.9% average reported by the Chemicals industry. Setting aside the industry comparison for now, Axalta Coating Systems’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
Take a look at the image below to see how Axalta Coating Systems’s past growth compares to the average in its industry.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Axalta Coating Systems.
Do Axalta Coating Systems’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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Axalta Coating Systems has total assets of US$6.7b and current liabilities of US$1.0b. As a result, its current liabilities are equal to approximately 15% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
What We Can Learn From Axalta Coating Systems’s ROCE
That said, Axalta Coating Systems’s ROCE is mediocre, there may be more attractive investments around. 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.
I will like Axalta Coating Systems better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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