Today we are going to look at Hunting plc (LON:HTG) to see whether it might be an attractive investment prospect. 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.
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.
Return On Capital Employed (ROCE): What is it?
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. 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?
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 Hunting:
0.037 = -US$18.4m ÷ (US$1.3b – US$144m) (Based on the trailing twelve months to June 2018.)
Therefore, Hunting has an ROCE of 3.7%.
Is Hunting’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Hunting’s ROCE appears to be significantly below the 7.5% average in the Energy Services industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Hunting compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.2% available in government bonds. There are potentially more appealing investments elsewhere.
Hunting’s current ROCE of 3.7% is lower than its ROCE in the past, which was 6.6%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Remember that most companies like Hunting are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Hunting.
What Are Current Liabilities, And How Do They Affect Hunting’s 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Hunting has total assets of US$1.3b and current liabilities of US$144m. Therefore its current liabilities are equivalent to approximately 11% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
Our Take On Hunting’s ROCE
While that is good to see, Hunting has a low ROCE and does not look attractive in this analysis. Of course you might be able to find a better stock than Hunting. 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).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.