Yahoo Finance Here’s why Huazhu Group Limited’s (NASDAQ:HTHT) Returns On Capital Matters So Much
Today we are going to look at Huazhu Group Limited (NASDAQ:HTHT) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the 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.
What is 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. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 Huazhu Group:
0.064 = CN¥2.1b ÷ (CN¥44b - CN¥10b) (Based on the trailing twelve months to September 2019.)
So, Huazhu Group has an ROCE of 6.4%.
See our latest analysis for Huazhu Group
Is Huazhu Group's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Huazhu Group's ROCE appears meaningfully below the 8.5% average reported by the Hospitality industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Huazhu Group stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
We can see that, Huazhu Group currently has an ROCE of 6.4%, less than the 12% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how Huazhu Group'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. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Huazhu Group.
Huazhu Group's Current Liabilities And Their Impact On 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Huazhu Group has total liabilities of CN¥10b and total assets of CN¥44b. Therefore its current liabilities are equivalent to approximately 24% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
What We Can Learn From Huazhu Group's ROCE
If Huazhu Group continues to earn an uninspiring ROCE, there may be better places to invest. You might be able to find a better investment than Huazhu Group. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like Huazhu Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
