Today we’ll evaluate Airtel Africa Plc (LON:AAF) to determine whether it could have potential as an investment idea. 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 up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared 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 is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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’.
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 Airtel Africa:
0.10 = US$751m ÷ (US$9.6b – US$2.5b) (Based on the trailing twelve months to September 2019.)
So, Airtel Africa has an ROCE of 10%.
Does Airtel Africa Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Airtel Africa’s ROCE appears to be substantially greater than the 8.3% average in the Wireless Telecom industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Airtel Africa compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can see in the image below how Airtel Africa’s ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Airtel Africa.
How Airtel Africa’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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Airtel Africa has total liabilities of US$2.5b and total assets of US$9.6b. Therefore its current liabilities are equivalent to approximately 26% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From Airtel Africa’s ROCE
With that in mind, Airtel Africa’s ROCE appears pretty good. Airtel Africa 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.
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If you spot an error that warrants correction, please contact the editor at email@example.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.
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