Why Hanwell Holdings Limited’s (SGX:DM0) Return On Capital Employed Might Be A Concern

Today we'll look at Hanwell Holdings Limited (SGX:DM0) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE 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. 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. 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 Hanwell Holdings:

0.065 = S$24m ÷ (S$488m - S$121m) (Based on the trailing twelve months to December 2019.)

Therefore, Hanwell Holdings has an ROCE of 6.5%.

See our latest analysis for Hanwell Holdings

Does Hanwell Holdings Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. We can see Hanwell Holdings's ROCE is meaningfully below the Packaging industry average of 10%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Hanwell Holdings stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

The image below shows how Hanwell Holdings'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. 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. How cyclical is Hanwell Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

How Hanwell Holdings's Current Liabilities Impact Its 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 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.

Hanwell Holdings has current liabilities of S$121m and total assets of S$488m. Therefore its current liabilities are equivalent to approximately 25% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

Our Take On Hanwell Holdings's ROCE

With that in mind, we're not overly impressed with Hanwell Holdings's ROCE, so it may not be the most appealing prospect. Of course, you might also be able to find a better stock than Hanwell Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

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

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.