Why Cameco Corporation’s (TSE:CCO) Return On Capital Employed Looks Uninspiring

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Today we are going to look at Cameco Corporation (TSE:CCO) 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.

Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.

Understanding 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. In general, businesses with a higher ROCE are usually better quality. 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 Cameco:

0.031 = CA$225m ÷ (CA$8.0b – CA$826m) (Based on the trailing twelve months to March 2019.)

Therefore, Cameco has an ROCE of 3.1%.

See our latest analysis for Cameco

Is Cameco’s ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, Cameco’s ROCE appears to be significantly below the 5.5% average in the Oil and Gas industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Cameco’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.

Cameco’s current ROCE of 3.1% is lower than its ROCE in the past, which was 5.2%, 3 years ago. This makes us wonder if the business is facing new challenges.

TSX:CCO Past Revenue and Net Income, June 27th 2019
TSX:CCO Past Revenue and Net Income, June 27th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. We note Cameco could be considered a cyclical business. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

What Are Current Liabilities, And How Do They Affect Cameco’s 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.

Cameco has total assets of CA$8.0b and current liabilities of CA$826m. As a result, its current liabilities are equal to approximately 10% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

The Bottom Line On Cameco’s ROCE

That’s not a bad thing, however Cameco has a weak ROCE and may not be an attractive investment. 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.