What Can We Make Of Neste Oyj’s (HEL:NESTE) High Return On Capital?

Today we are going to look at Neste Oyj (HEL:NESTE) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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?

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 Neste Oyj:

0.19 = €1.1b ÷ (€8.2b – €2.2b) (Based on the trailing twelve months to December 2018.)

So, Neste Oyj has an ROCE of 19%.

View our latest analysis for Neste Oyj

Does Neste Oyj Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Neste Oyj’s ROCE is meaningfully higher than the 11% average in the Oil and Gas industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Putting aside its position relative to its industry for now, in absolute terms, Neste Oyj’s ROCE is currently very good.

As we can see, Neste Oyj currently has an ROCE of 19% compared to its ROCE 3 years ago, which was 12%. This makes us think about whether the company has been reinvesting shrewdly.

HLSE:NESTE Past Revenue and Net Income, April 16th 2019
HLSE:NESTE Past Revenue and Net Income, April 16th 2019

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, Neste Oyj could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Neste Oyj.

What Are Current Liabilities, And How Do They Affect Neste Oyj’s 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Neste Oyj has total assets of €8.2b and current liabilities of €2.2b. As a result, its current liabilities are equal to approximately 27% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.

Our Take On Neste Oyj’s ROCE

This is good to see, and with such a high ROCE, Neste Oyj may be worth a closer look. Neste Oyj looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

I will like Neste Oyj 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.