Today we are going to look at Melco Resorts & Entertainment Limited (NASDAQ:MLCO) 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 of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.’
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 Melco Resorts & Entertainment:
0.083 = US$631m ÷ (US$8.8b – US$1.8b) (Based on the trailing twelve months to September 2018.)
So, Melco Resorts & Entertainment has an ROCE of 8.3%.
Does Melco Resorts & Entertainment Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see Melco Resorts & Entertainment’s ROCE is around the 10% average reported by the Hospitality industry. Aside from the industry comparison, Melco Resorts & Entertainment’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.
As we can see, Melco Resorts & Entertainment currently has an ROCE of 8.3% compared to its ROCE 3 years ago, which was 2.4%. This makes us think about whether the company has been reinvesting shrewdly.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. 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 Melco Resorts & Entertainment.
Do Melco Resorts & Entertainment’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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Melco Resorts & Entertainment has total assets of US$8.8b and current liabilities of US$1.8b. Therefore its current liabilities are equivalent to approximately 21% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
Our Take On Melco Resorts & Entertainment’s ROCE
With that in mind, we’re not overly impressed with Melco Resorts & Entertainment’s ROCE, so it may not be the most appealing prospect. But note: Melco Resorts & Entertainment 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).
Of course Melco Resorts & Entertainment 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 email@example.com.