Today we are going to look at OCI N.V. (AMS:OCI) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
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 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. 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?
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 OCI:
0.064 = US$188m ÷ (US$7.2b – US$963m) (Based on the trailing twelve months to September 2018.)
So, OCI has an ROCE of 6.4%.
Is OCI’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, OCI’s ROCE appears meaningfully below the 11% average reported by the Chemicals industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, OCI’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for OCI.
Do OCI’s Current Liabilities Skew Its ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. 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) unfairly boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
OCI has total assets of US$7.2b and current liabilities of US$963m. As a result, its current liabilities are equal to approximately 13% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
The Bottom Line On OCI’s ROCE
That said, OCI’s ROCE is mediocre, there may be more attractive investments around. The ROCE can give us an idea of the quality of a business, but we need to look deeper if we are considering a purchase. One data point to check is if insiders have bought shares recently.
Of course OCI 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 firstname.lastname@example.org.