Is China Mengniu Dairy Company Limited (HKG:2319) Struggling With Its 7.8% Return On Capital Employed?

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Today we’ll evaluate China Mengniu Dairy Company Limited (HKG:2319) 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.

First up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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 China Mengniu Dairy:

0.078 = CN¥3.1b ÷ (CN¥62b – CN¥25b) (Based on the trailing twelve months to June 2018.)

Therefore, China Mengniu Dairy has an ROCE of 7.8%.

Check out our latest analysis for China Mengniu Dairy

Does China Mengniu Dairy Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, China Mengniu Dairy’s ROCE appears meaningfully below the 12% average reported by the Food industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, China Mengniu Dairy’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for China Mengniu Dairy.

Do China Mengniu Dairy’s Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

China Mengniu Dairy has total assets of CN¥62b and current liabilities of CN¥25b. As a result, its current liabilities are equal to approximately 41% of its total assets. China Mengniu Dairy’s middling level of current liabilities have the effect of boosting its ROCE a bit.

Our Take On China Mengniu Dairy’s ROCE

Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. You might be able to find a better buy than China Mengniu Dairy. 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).

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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 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. Thank you for reading.