Today we are going to look at BlueScope Steel Limited (ASX:BSL) 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.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect 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. In general, businesses with a higher ROCE are usually better quality. 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.
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 BlueScope Steel:
0.083 = AU$758m ÷ (AU$12b - AU$2.5b) (Based on the trailing twelve months to December 2019.)
Therefore, BlueScope Steel has an ROCE of 8.3%.
Is BlueScope Steel's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. It appears that BlueScope Steel's ROCE is fairly close to the Metals and Mining industry average of 9.8%. Setting aside the industry comparison for now, BlueScope Steel's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
BlueScope Steel's current ROCE of 8.3% is lower than 3 years ago, when the company reported a 12% ROCE. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how BlueScope Steel's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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, after all, simply a snap shot of a single year. We note BlueScope Steel could be considered a cyclical business. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect BlueScope Steel's 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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
BlueScope Steel has total assets of AU$12b and current liabilities of AU$2.5b. Therefore its current liabilities are equivalent to approximately 21% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
Our Take On BlueScope Steel's ROCE
If BlueScope Steel continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might also be able to find a better stock than BlueScope Steel. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.