Today we’ll evaluate SATS Ltd. (SGX:S58) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into 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 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. 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 SATS:
0.11 = S$240m ÷ (S$2.6b – S$448m) (Based on the trailing twelve months to December 2019.)
So, SATS has an ROCE of 11%.
Is SATS’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. SATS’s ROCE appears to be substantially greater than the 6.7% average in the Infrastructure industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where SATS sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
You can click on the image below to see (in greater detail) how SATS’s past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for SATS.
Do SATS’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 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.
SATS has current liabilities of S$448m and total assets of S$2.6b. Therefore its current liabilities are equivalent to approximately 17% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On SATS’s ROCE
With that in mind, SATS’s ROCE appears pretty good. There might be better investments than SATS out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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