Why You Should Care About Healius Limited’s (ASX:HLS) Low Return On Capital

Today we are going to look at Healius Limited (ASX:HLS) 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 up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared 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. All else being equal, a better business will have a higher ROCE. In brief, ROCE 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’.

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 Healius:

0.041 = AU$114m ÷ (AU$3.1b – AU$375m) (Based on the trailing twelve months to June 2018.)

Therefore, Healius has an ROCE of 4.1%.

Check out our latest analysis for Healius

Is Healius’s ROCE Good?

One way to assess ROCE is to compare similar companies. In this analysis, Healius’s ROCE appears meaningfully below the 11% average reported by the Healthcare industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Healius compares to its industry, its ROCE in absolute terms is low; not much better than the ~2.8% available in government bonds. Readers may wish to look for more rewarding investments.

Healius’s current ROCE of 4.1% is lower than 3 years ago, when the company reported a 6.6% ROCE. Therefore we wonder if the company is facing new headwinds.

ASX:HLS Last Perf January 5th 19
ASX:HLS Last Perf January 5th 19

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Healius.

How Healius’s Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Healius has total liabilities of AU$375m and total assets of AU$3.1b. As a result, its current liabilities are equal to approximately 12% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.

Our Take On Healius’s ROCE

While that is good to see, Healius has a low ROCE and does not look attractive in this analysis. We prefer to see a high ROCE, but even a low quality business can be a good buy at the right price. So it might be wise to check if insiders have been buying.

But note: Healius may not be the best stock to buy. So take a peek at this free list of interesting companies with high ROE and low debt.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.