Why Hanison Construction Holdings Limited’s (HKG:896) Return On Capital Employed Looks Uninspiring
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Today we’ll evaluate Hanison Construction Holdings Limited (HKG:896) to determine whether it could have potential as an investment idea. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
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.
Return On Capital Employed (ROCE): What is it?
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 Hanison Construction Holdings:
0.013 = HK$103m ÷ (HK$6.5b – HK$2.3b) (Based on the trailing twelve months to September 2018.)
So, Hanison Construction Holdings has an ROCE of 1.3%.
View our latest analysis for Hanison Construction Holdings
Is Hanison Construction Holdings’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Hanison Construction Holdings’s ROCE appears meaningfully below the 14% average reported by the Construction industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Hanison Construction Holdings compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.0% available in government bonds. There are potentially more appealing investments elsewhere.
Hanison Construction Holdings’s current ROCE of 1.3% is lower than its ROCE in the past, which was 11%, 3 years ago. This makes us wonder if the business is facing new challenges.
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, after all, simply a snap shot of a single year. How cyclical is Hanison Construction Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Hanison Construction 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 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.
Hanison Construction Holdings has total assets of HK$6.5b and current liabilities of HK$2.3b. Therefore its current liabilities are equivalent to approximately 36% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Hanison Construction Holdings’s ROCE is concerning.
The Bottom Line On Hanison Construction Holdings’s ROCE
This company may not be the most attractive investment prospect. 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.
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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.
