Is Emera Incorporated’s (TSE:EMA) Capital Allocation Ability Worth Your Time?

Today we are going to look at Emera Incorporated (TSE:EMA) 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 of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.

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

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 Emera:

0.053 = CA$1.4b ÷ (CA$31b – CA$3.9b) (Based on the trailing twelve months to June 2019.)

So, Emera has an ROCE of 5.3%.

Check out our latest analysis for Emera

Is Emera’s ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. It appears that Emera’s ROCE is fairly close to the Electric Utilities industry average of 4.9%. Setting aside the industry comparison for now, Emera’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.

We can see that , Emera currently has an ROCE of 5.3% compared to its ROCE 3 years ago, which was 3.2%. This makes us think the business might be improving.

TSX:EMA Past Revenue and Net Income, August 23rd 2019
TSX:EMA Past Revenue and Net Income, August 23rd 2019

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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. 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 Emera’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.

Emera has total assets of CA$31b and current liabilities of CA$3.9b. Therefore its current liabilities are equivalent to approximately 13% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

Our Take On Emera’s ROCE

That said, Emera’s ROCE is mediocre, there may be more attractive investments around. You might be able to find a better investment than Emera. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

I will like Emera better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 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.