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Today we’ll evaluate Horizon North Logistics Inc. (TSE:HNL) 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.
First up, we’ll look at what ROCE is and how we calculate it. 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.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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’.
How Do You Calculate Return On Capital Employed?
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 Horizon North Logistics:
0.014 = CA$6.3m ÷ (CA$513m – CA$69m) (Based on the trailing twelve months to March 2019.)
Therefore, Horizon North Logistics has an ROCE of 1.4%.
Is Horizon North Logistics’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Horizon North Logistics’s ROCE appears to be significantly below the 7.6% average in the Commercial Services industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Horizon North Logistics compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.9% available in government bonds. Readers may wish to look for more rewarding investments.
Horizon North Logistics reported an ROCE of 1.4% — better than 3 years ago, when the company didn’t make a profit. That suggests the business has returned to profitability.
It is important to remember that ROCE shows past performance, and is 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Horizon North Logistics.
Do Horizon North Logistics’s Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.
Horizon North Logistics has total liabilities of CA$69m and total assets of CA$513m. As a result, its current liabilities are equal to approximately 14% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
The Bottom Line On Horizon North Logistics’s ROCE
Horizon North Logistics has a poor ROCE, and there may be better investment prospects out there. 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).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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 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. Thank you for reading.