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Today we’ll look at Convenience Retail Asia Limited (HKG:831) and reflect on its potential as an investment. 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, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on 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. 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?

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 Convenience Retail Asia:

0.30 = HK$183m ÷ (HK$1.7b – HK$1.1b) (Based on the trailing twelve months to June 2018.)

Therefore, Convenience Retail Asia has an ROCE of 30%.

View our latest analysis for Convenience Retail Asia

Does Convenience Retail Asia Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Convenience Retail Asia’s ROCE is meaningfully higher than the 10% average in the Consumer Retailing industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, Convenience Retail Asia’s ROCE is currently very good.

As we can see, Convenience Retail Asia currently has an ROCE of 30% compared to its ROCE 3 years ago, which was 23%. This makes us think the business might be improving.

When considering this metric, keep in mind that it is backwards looking, and 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 only a point-in-time measure. How cyclical is Convenience Retail Asia? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Convenience Retail Asia’s Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Convenience Retail Asia has total assets of HK$1.7b and current liabilities of HK$1.1b. As a result, its current liabilities are equal to approximately 63% of its total assets. Convenience Retail Asia boasts an attractive ROCE, even after considering the boost from high current liabilities.

What We Can Learn From Convenience Retail Asia’s ROCE

So we would be interested in doing more research here — there may be an opportunity! 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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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.