Why We’re Not Impressed By TPG Telecom Limited’s (ASX:TPM) 13% ROCE

Today we are going to look at TPG Telecom Limited (ASX:TPM) to see whether it might be an attractive investment prospect. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its 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. Finally, we’ll look at how its current liabilities affect 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 the end, ROCE 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.’

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 TPG Telecom:

0.13 = AU$598m ÷ (AU$5.4b – AU$885m) (Based on the trailing twelve months to July 2018.)

So, TPG Telecom has an ROCE of 13%.

See our latest analysis for TPG Telecom

Does TPG Telecom Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that TPG Telecom’s ROCE is meaningfully better than the 9.8% average in the Telecom industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how TPG Telecom compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

TPG Telecom’s current ROCE of 13% is lower than 3 years ago, when the company reported a 24% ROCE. Therefore we wonder if the company is facing new headwinds.

ASX:TPM Last Perf December 20th 18
ASX:TPM Last Perf December 20th 18

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the 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 TPG Telecom.

TPG Telecom’s Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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) unfairly boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.

TPG Telecom has total liabilities of AU$885m and total assets of AU$5.4b. As a result, its current liabilities are equal to approximately 16% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

What We Can Learn From TPG Telecom’s ROCE

With that in mind, TPG Telecom’s ROCE appears pretty good. But note: TPG Telecom may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

But note: TPG Telecom 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.