Here’s why China Resources Beer (Holdings) Company Limited’s (HKG:291) Returns On Capital Matters So Much

Today we are going to look at China Resources Beer (Holdings) Company Limited (HKG:291) to see whether it might be an attractive investment prospect. 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. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, ROCE is a useful tool, but it is not without drawbacks. 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?

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 China Resources Beer (Holdings):

0.10 = CN¥1.5b ÷ (CN¥44b - CN¥22b) (Based on the trailing twelve months to June 2018.)

Therefore, China Resources Beer (Holdings) has an ROCE of 10%.

See our latest analysis for China Resources Beer (Holdings)

Is China Resources Beer (Holdings)'s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that China Resources Beer (Holdings)'s ROCE is meaningfully better than the 3.0% average in the Beverage industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how China Resources Beer (Holdings) compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Our data shows that China Resources Beer (Holdings) currently has an ROCE of 10%, compared to its ROCE of 2.4% 3 years ago. This makes us think the business might be improving.

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. ROCE is, after all, simply a snap shot of a single year. You can see analyst predictions in our freereport on analyst forecasts for the company.

How China Resources Beer (Holdings)'s Current Liabilities Impact Its 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 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.

China Resources Beer (Holdings) has total assets of CN¥44b and current liabilities of CN¥22b. As a result, its current liabilities are equal to approximately 50% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.

Our Take On China Resources Beer (Holdings)'s ROCE

The ROCE would not look as appealing if the company had fewer current liabilities. While the ROCE is useful information, it is not always predictive. We need to do more work before making a decision. For example, I often check if insiders have been buying shares .

Of course China Resources Beer (Holdings) may not be the best stock to buy. So you may wish to see this free collection of other companies that have high ROE and low debt.

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 editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.