Today we are going to look at Whitbread PLC (LON:WTB) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
How Do You Calculate Return On Capital Employed?
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 Whitbread:
0.056 = UK£400m ÷ (UK£7.8b - UK£622m) (Based on the trailing twelve months to August 2019.)
So, Whitbread has an ROCE of 5.6%.
Is Whitbread's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Whitbread's ROCE appears meaningfully below the 7.8% average reported by the Hospitality industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Whitbread 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.
Whitbread's current ROCE of 5.6% is lower than its ROCE in the past, which was 15%, 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Whitbread's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Whitbread.
Whitbread's Current Liabilities And Their Impact On Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.
Whitbread has total assets of UK£7.8b and current liabilities of UK£622m. Therefore its current liabilities are equivalent to approximately 8.0% of its total assets. Whitbread reports few current liabilities, which have a negligible impact on its unremarkable ROCE.
What We Can Learn From Whitbread's ROCE
Based on this information, Whitbread appears to be a mediocre business. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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