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.
Firstly, we’ll go over how we 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.
What is 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. In general, businesses with a higher ROCE are usually better quality. 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.
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 Airtel Africa:
0.12 = US$750m ÷ (US$9.1b – US$2.6b) (Based on the trailing twelve months to June 2019.)
Therefore, Airtel Africa has an ROCE of 12%.
Is Airtel Africa’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Airtel Africa’s ROCE appears to be substantially greater than the 9.7% average in the Wireless Telecom industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Airtel Africa sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
You can click on the image below to see (in greater detail) how Airtel Africa’s past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Airtel Africa.
Airtel Africa’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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Airtel Africa has total assets of US$9.1b and current liabilities of US$2.6b. As a result, its current liabilities are equal to approximately 29% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On Airtel Africa’s ROCE
This is good to see, and with a sound ROCE, Airtel Africa could be worth a closer look. 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 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.