Examining AP Rentals Holdings Limited’s (HKG:1496) Weak Return On Capital Employed

Today we’ll look at AP Rentals Holdings Limited (HKG:1496) and reflect on its potential as an investment. 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. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 AP Rentals Holdings:

0.004 = HK$16m ÷ (HK$321m – HK$51m) (Based on the trailing twelve months to September 2018.)

Therefore, AP Rentals Holdings has an ROCE of 0.4%.

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Does AP Rentals Holdings Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, AP Rentals Holdings’s ROCE appears to be significantly below the 6.0% average in the Trade Distributors industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how AP Rentals Holdings stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.

AP Rentals Holdings’s current ROCE of 0.4% is lower than its ROCE in the past, which was 36%, 3 years ago. So investors might consider if it has had issues recently.

SEHK:1496 Last Perf January 18th 19
SEHK:1496 Last Perf January 18th 19

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 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. You can check if AP Rentals Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Do AP Rentals Holdings’s Current Liabilities Skew 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 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.

AP Rentals Holdings has total assets of HK$321m and current liabilities of HK$51m. Therefore its current liabilities are equivalent to approximately 16% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.

The Bottom Line On AP Rentals Holdings’s ROCE

AP Rentals Holdings has a poor ROCE, and there may be better investment prospects out there. But note: AP Rentals Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

I will like AP Rentals Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.