Why We Like Zodiac Energy Limited’s (NSE:ZODIAC) 15% Return On Capital Employed

Today we’ll evaluate Zodiac Energy Limited (NSE:ZODIAC) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’

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 Zodiac Energy:

0.15 = ₹30m ÷ (₹235m – ₹49m) (Based on the trailing twelve months to September 2018.)

Therefore, Zodiac Energy has an ROCE of 15%.

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Does Zodiac Energy Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. It appears that Zodiac Energy’s ROCE is fairly close to the Electrical industry average of 15%. Aside from the industry comparison, Zodiac Energy’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

NSEI:ZODIAC Last Perf January 14th 19
NSEI:ZODIAC Last Perf January 14th 19

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Zodiac Energy? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Zodiac Energy’s Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Zodiac Energy has total liabilities of ₹49m and total assets of ₹235m. Therefore its current liabilities are equivalent to approximately 21% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

Our Take On Zodiac Energy’s ROCE

If Zodiac Energy continues to earn an uninspiring ROCE, there may be better places to invest. You might be able to find a better buy than Zodiac Energy. 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).

I will like Zodiac Energy better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.