Today we’ll evaluate Public Joint Stock Company “Sakhalinenergo” (MCX:SLEN) 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 up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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 Sakhalinenergo:
0.42 = RUруб633m ÷ (RUруб7.8b – RUруб5.1b) (Based on the trailing twelve months to June 2018.)
Therefore, Sakhalinenergo has an ROCE of 42%.
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Is Sakhalinenergo’s ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, Sakhalinenergo’s ROCE is meaningfully higher than the 9.7% average in the Electric Utilities industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Sakhalinenergo’s ROCE in absolute terms currently looks quite high.
Sakhalinenergo reported an ROCE of 42% — better than 3 years ago, when the company didn’t make a profit. This makes us wonder if the company is 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 only a point-in-time measure. You can check if Sakhalinenergo has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Sakhalinenergo’s Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Sakhalinenergo has total liabilities of RUруб5.1b and total assets of RUруб7.8b. As a result, its current liabilities are equal to approximately 65% of its total assets. Sakhalinenergo boasts an attractive ROCE, even after considering the boost from high current liabilities.
The Bottom Line On Sakhalinenergo’s ROCE
So to us, the company is potentially worth investigating further. You might be able to find a better buy than Sakhalinenergo. 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).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.