Why Sanderson Farms, Inc.’s (NASDAQ:SAFM) Return On Capital Employed Looks Uninspiring

Today we’ll evaluate Sanderson Farms, Inc. (NASDAQ:SAFM) to determine whether it could have potential as an investment idea. 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, 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.

Return On Capital Employed (ROCE): What is it?

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. In the end, ROCE is a valuable metric that has its flaws. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.

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 Sanderson Farms:

0.12 = US$425m ÷ (US$1.8b – US$189m) (Based on the trailing twelve months to July 2018.)

Therefore, Sanderson Farms has an ROCE of 12%.

See our latest analysis for Sanderson Farms

Is Sanderson Farms’s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Sanderson Farms’s ROCE appears to be substantially greater than the 9.5% average in the Food industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Sanderson Farms compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Sanderson Farms’s current ROCE of 12% is lower than its ROCE in the past, which was 40%, 3 years ago. Therefore we wonder if the company is facing new headwinds.

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

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Sanderson Farms.

Do Sanderson Farms’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.

Sanderson Farms has total liabilities of US$189m and total assets of US$1.8b. Therefore its current liabilities are equivalent to approximately 11% of its total assets.

The Bottom Line On Sanderson Farms’s ROCE

Low current liabilities are not boosting the ROCE too much. With that in mind, Sanderson Farms’s ROCE appears pretty good. While the ROCE is useful information, it is not always predictive. We need to do more work before making a decision. One data point to check is if insiders have bought shares recently.

Of course Sanderson Farms 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 editorial-team@simplywallst.com.