Today we are going to look at China Mengniu Dairy Company Limited (HKG:2319) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 China Mengniu Dairy:
0.096 = CN¥3.7b ÷ (CN¥74b – CN¥35b) (Based on the trailing twelve months to June 2019.)
So, China Mengniu Dairy has an ROCE of 9.6%.
Is China Mengniu Dairy’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. It appears that China Mengniu Dairy’s ROCE is fairly close to the Food industry average of 10%. Independently of how China Mengniu Dairy compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
In our analysis, China Mengniu Dairy’s ROCE appears to be 9.6%, compared to 3 years ago, when its ROCE was 6.7%. This makes us think the business might be improving. The image below shows how China Mengniu Dairy’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for China Mengniu Dairy.
How China Mengniu Dairy’s Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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.
China Mengniu Dairy has total assets of CN¥74b and current liabilities of CN¥35b. Therefore its current liabilities are equivalent to approximately 47% of its total assets. China Mengniu Dairy has a medium level of current liabilities, which would boost the ROCE.
The Bottom Line On China Mengniu Dairy’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. China Mengniu Dairy shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
I will like China Mengniu Dairy better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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