Should Kenmare Resources plc’s (LON:KMR) Weak Investment Returns Worry You?

Today we’ll evaluate Kenmare Resources plc (LON:KMR) 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.

Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on 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. In general, businesses with a higher ROCE are usually better quality. 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?

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 Kenmare Resources:

0.059 = US$56m ÷ (US$1.0b – US$53m) (Based on the trailing twelve months to June 2019.)

Therefore, Kenmare Resources has an ROCE of 5.9%.

See our latest analysis for Kenmare Resources

Is Kenmare Resources’s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, Kenmare Resources’s ROCE appears to be significantly below the 13% average in the Metals and Mining industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Kenmare Resources stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.

Kenmare Resources has an ROCE of 5.9%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving. You can see in the image below how Kenmare Resources’s ROCE compares to its industry. Click to see more on past growth.

LSE:KMR Past Revenue and Net Income, March 5th 2020
LSE:KMR Past Revenue and Net Income, March 5th 2020

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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. We note Kenmare Resources could be considered a cyclical business. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Kenmare Resources’s Current Liabilities Skew 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 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.

Kenmare Resources has total assets of US$1.0b and current liabilities of US$53m. As a result, its current liabilities are equal to approximately 5.2% of its total assets. Kenmare Resources has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.

The Bottom Line On Kenmare Resources’s ROCE

If performance improves, then Kenmare Resources may be an OK investment, especially at the right valuation. 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.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.

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. Thank you for reading.