Should You Worry About SML Isuzu Limited’s (NSE:SMLISUZU) ROCE?

Today we are going to look at SML Isuzu Limited (NSE:SMLISUZU) to see whether it might be an attractive investment prospect. 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.

Firstly, we’ll go over how we calculate ROCE. 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. 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. 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 SML Isuzu:

0.05 = ₹162m ÷ (₹8.8b – ₹2.9b) (Based on the trailing twelve months to September 2018.)

So, SML Isuzu has an ROCE of 5.0%.

See our latest analysis for SML Isuzu

Is SML Isuzu’s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, SML Isuzu’s ROCE appears to be significantly below the 15% average in the Machinery industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how SML Isuzu stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.

As we can see, SML Isuzu currently has an ROCE of 5.0%, less than the 16% it reported 3 years ago. This makes us wonder if the business is facing new challenges.

NSEI:SMLISUZU Last Perf January 8th 19
NSEI:SMLISUZU Last Perf January 8th 19

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. Since the future is so important for investors, you should check out our free report on analyst forecasts for SML Isuzu.

What Are Current Liabilities, And How Do They Affect SML Isuzu’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 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 counter this, investors can check if a company has high current liabilities relative to total assets.

SML Isuzu has total assets of ₹8.8b and current liabilities of ₹2.9b. As a result, its current liabilities are equal to approximately 33% of its total assets. With a medium level of current liabilities boosting the ROCE a little, SML Isuzu’s low ROCE is unappealing.

What We Can Learn From SML Isuzu’s ROCE

There are likely better investments out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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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.