Why Fortum Oyj’s (HEL:FORTUM) Return On Capital Employed Might Be A Concern

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Today we’ll evaluate Fortum Oyj (HEL:FORTUM) to determine whether it could have potential as an investment idea. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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?

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 Fortum Oyj:

0.048 = €964m ÷ (€23b – €3.2b) (Based on the trailing twelve months to March 2019.)

Therefore, Fortum Oyj has an ROCE of 4.8%.

View our latest analysis for Fortum Oyj

Does Fortum Oyj Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Fortum Oyj’s ROCE appears meaningfully below the 7.6% average reported by the Electric Utilities industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Setting aside the industry comparison for now, Fortum Oyj’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

In our analysis, Fortum Oyj’s ROCE appears to be 4.8%, compared to 3 years ago, when its ROCE was 3.5%. This makes us think about whether the company has been reinvesting shrewdly.

HLSE:FORTUM Past Revenue and Net Income, June 17th 2019
HLSE:FORTUM Past Revenue and Net Income, June 17th 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. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Fortum Oyj.

How Fortum Oyj’s Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Fortum Oyj has total assets of €23b and current liabilities of €3.2b. As a result, its current liabilities are equal to approximately 14% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

Our Take On Fortum Oyj’s ROCE

If Fortum Oyj continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.