Today we are going to look at Iluka Resources Limited (ASX:ILU) 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.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.
So, How Do We Calculate ROCE?
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 Iluka Resources:
0.25 = AU$502m ÷ (AU$2.3b - AU$281m) (Based on the trailing twelve months to June 2019.)
So, Iluka Resources has an ROCE of 25%.
Is Iluka Resources's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Iluka Resources's ROCE is meaningfully better than the 8.0% average in the Metals and Mining industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Iluka Resources's ROCE is currently very good.
We can see that, Iluka Resources currently has an ROCE of 25% compared to its ROCE 3 years ago, which was 5.0%. This makes us think the business might be improving. You can see in the image below how Iluka Resources's ROCE compares to its industry. Click to see more on past growth.
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. ROCE is only a point-in-time measure. We note Iluka Resources could be considered a cyclical business. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Iluka Resources.
How Iluka Resources'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 counter this, investors can check if a company has high current liabilities relative to total assets.
Iluka Resources has total assets of AU$2.3b and current liabilities of AU$281m. As a result, its current liabilities are equal to approximately 12% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
The Bottom Line On Iluka Resources's ROCE
, There might be better investments than Iluka Resources out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.