Why We Like HD Supply Holdings, Inc.’s (NASDAQ:HDS) 20% Return On Capital Employed

Today we are going to look at HD Supply Holdings, Inc. (NASDAQ:HDS) 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.

First, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. In the end, ROCE 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.’

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 HD Supply Holdings:

0.20 = US$614m ÷ (US$4.4b – US$860m) (Based on the trailing twelve months to October 2018.)

Therefore, HD Supply Holdings has an ROCE of 20%.

See our latest analysis for HD Supply Holdings

Is HD Supply Holdings’s ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, HD Supply Holdings’s ROCE is meaningfully higher than the 8.0% average in the Trade Distributors industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from HD Supply Holdings’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

NasdaqGS:HDS Last Perf December 11th 18
NasdaqGS:HDS Last Perf December 11th 18

It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for HD Supply Holdings.

What Are Current Liabilities, And How Do They Affect HD Supply Holdings’s ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

HD Supply Holdings has total assets of US$4.4b and current liabilities of US$860m. Therefore its current liabilities are equivalent to approximately 19% of its total assets.

The Bottom Line On HD Supply Holdings’s ROCE

Current liabilities are minimal, limiting the impact on ROCE. This is good to see, and with a sound ROCE, HD Supply Holdings could be worth a closer look. But note: HD Supply Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

But note: HD Supply Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with 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 editorial-team@simplywallst.com.