Today we’ll evaluate CF Industries Holdings, Inc. (NYSE:CF) 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. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 CF Industries Holdings:
0.05 = US$225m ÷ (US$13b – US$788m) (Based on the trailing twelve months to September 2018.)
So, CF Industries Holdings has an ROCE of 5.0%.
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Does CF Industries Holdings Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, CF Industries Holdings’s ROCE appears to be significantly below the 12% average in the Chemicals industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how CF Industries Holdings stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.
CF Industries Holdings’s current ROCE of 5.0% is lower than 3 years ago, when the company reported a 12% ROCE. Therefore we wonder if the company is facing new headwinds.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for CF Industries Holdings.
How CF Industries 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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
CF Industries Holdings has total assets of US$13b and current liabilities of US$788m. Therefore its current liabilities are equivalent to approximately 6.0% of its total assets. CF Industries Holdings has very few current liabilities, which have a minimal effect on its already low ROCE.
The Bottom Line On CF Industries Holdings’s ROCE
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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.