Here’s What Kirkland Lake Gold Ltd.’s (TSE:KL) ROCE Can Tell Us

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Today we’ll evaluate Kirkland Lake Gold Ltd. (TSE:KL) 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.

Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

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. 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’.

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 Kirkland Lake Gold:

0.22 = US$206m ÷ (US$1.6b – US$162m) (Based on the trailing twelve months to September 2018.)

Therefore, Kirkland Lake Gold has an ROCE of 22%.

Check out our latest analysis for Kirkland Lake Gold

Is Kirkland Lake Gold’s ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Kirkland Lake Gold’s ROCE is meaningfully better than the 2.7% average in the Metals and Mining industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Kirkland Lake Gold’s ROCE in absolute terms currently looks quite high.

Our data shows that Kirkland Lake Gold currently has an ROCE of 22%, compared to its ROCE of 9.4% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.

TSX:KL Past Revenue and Net Income, February 19th 2019
TSX:KL Past Revenue and Net Income, February 19th 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. ROCE is, after all, simply a snap shot of a single year. Remember that most companies like Kirkland Lake Gold are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Kirkland Lake Gold.

How Kirkland Lake Gold’s Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.

Kirkland Lake Gold has total liabilities of US$162m and total assets of US$1.6b. As a result, its current liabilities are equal to approximately 10% of its total assets. The fairly low level of current liabilities won’t have much impact on the already great ROCE.

The Bottom Line On Kirkland Lake Gold’s ROCE

This is good to see, and with such a high ROCE, Kirkland Lake Gold may be worth a closer look. Of course you might be able to find a better stock than Kirkland Lake Gold. So you may wish to see this free collection of other companies that have grown earnings strongly.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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. On rare occasion, data errors may occur. Thank you for reading.