Today we'll evaluate Tigers Realm Coal Limited (ASX:TIG) 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.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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?
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 Tigers Realm Coal:
0.17 = AU$5.7m ÷ (AU$79m - AU$46m) (Based on the trailing twelve months to June 2019.)
Therefore, Tigers Realm Coal has an ROCE of 17%.
Does Tigers Realm Coal Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In our analysis, Tigers Realm Coal's ROCE is meaningfully higher than the 7.9% 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. Regardless of where Tigers Realm Coal sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Tigers Realm Coal delivered an ROCE of 17%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Tigers Realm Coal's past growth compares to other companies.
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 Tigers Realm Coal could be considered a cyclical business. How cyclical is Tigers Realm Coal? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Tigers Realm Coal's 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Tigers Realm Coal has total assets of AU$79m and current liabilities of AU$46m. As a result, its current liabilities are equal to approximately 58% of its total assets. Tigers Realm Coal has a relatively high level of current liabilities, boosting its ROCE meaningfully.
Our Take On Tigers Realm Coal's ROCE
The ROCE would not look as appealing if the company had fewer current liabilities. There might be better investments than Tigers Realm Coal 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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.