Examining Speedcast International Limited’s (ASX:SDA) Weak Return On Capital Employed

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Today we’ll look at Speedcast International Limited (ASX:SDA) and reflect on its potential as an investment. 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.

First up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 Speedcast International:

0.057 = US$54m ÷ (US$1.2b – US$262m) (Based on the trailing twelve months to December 2018.)

So, Speedcast International has an ROCE of 5.7%.

Check out our latest analysis for Speedcast International

Is Speedcast International’s ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, Speedcast International’s ROCE appears to be significantly below the 8.2% average in the Telecom industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Speedcast International’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

Speedcast International’s current ROCE of 5.7% is lower than 3 years ago, when the company reported a 10% ROCE. This makes us wonder if the business is facing new challenges.

ASX:SDA Past Revenue and Net Income, April 30th 2019
ASX:SDA Past Revenue and Net Income, April 30th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Speedcast International.

Do Speedcast International’s Current Liabilities Skew 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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Speedcast International has total assets of US$1.2b and current liabilities of US$262m. Therefore its current liabilities are equivalent to approximately 21% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

The Bottom Line On Speedcast International’s ROCE

If Speedcast International continues to earn an uninspiring ROCE, there may be better places to invest. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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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.

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. Thank you for reading.