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Today we are going to look at TransAlta Renewables Inc. (TSE:RNW) 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. 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. All else being equal, a better business will have a higher ROCE. 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’.
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 TransAlta Renewables:
0.041 = CA$148m ÷ (CA$3.8b – CA$159m) (Based on the trailing twelve months to March 2019.)
Therefore, TransAlta Renewables has an ROCE of 4.1%.
Is TransAlta Renewables’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. It appears that TransAlta Renewables’s ROCE is fairly close to the Renewable Energy industry average of 4.0%. Independently of how TransAlta Renewables compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.9% available in government bonds. It is likely that there are more attractive prospects out there.
In our analysis, TransAlta Renewables’s ROCE appears to be 4.1%, compared to 3 years ago, when its ROCE was 2.6%. This makes us wonder if the company is improving.
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. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
TransAlta Renewables’s Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 counter this, investors can check if a company has high current liabilities relative to total assets.
TransAlta Renewables has total assets of CA$3.8b and current liabilities of CA$159m. Therefore its current liabilities are equivalent to approximately 4.2% of its total assets. TransAlta Renewables has very few current liabilities, which have a minimal effect on its already low ROCE.
What We Can Learn From TransAlta Renewables’s ROCE
Nevertheless, there are potentially more attractive companies to invest in. 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).
I will like TransAlta Renewables 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 firstname.lastname@example.org. 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.