Today we’ll evaluate China Unicom (Hong Kong) Limited (HKG:762) to determine whether it could have potential as an investment idea. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting 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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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?
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 China Unicom (Hong Kong):
0.043 = CN¥15b ÷ (CN¥565b – CN¥211b) (Based on the trailing twelve months to September 2019.)
So, China Unicom (Hong Kong) has an ROCE of 4.3%.
Does China Unicom (Hong Kong) Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see China Unicom (Hong Kong)’s ROCE is meaningfully below the Telecom industry average of 6.7%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how China Unicom (Hong Kong) compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.6% available in government bonds. It is likely that there are more attractive prospects out there.
Our data shows that China Unicom (Hong Kong) currently has an ROCE of 4.3%, compared to its ROCE of 0.3% 3 years ago. This makes us think the business might be improving. The image below shows how China Unicom (Hong Kong)’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do China Unicom (Hong Kong)’s Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
China Unicom (Hong Kong) has total assets of CN¥565b and current liabilities of CN¥211b. Therefore its current liabilities are equivalent to approximately 37% of its total assets. With a medium level of current liabilities boosting the ROCE a little, China Unicom (Hong Kong)’s low ROCE is unappealing.
Our Take On China Unicom (Hong Kong)’s ROCE
There are likely better investments out there. You might be able to find a better investment than China Unicom (Hong Kong). If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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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