Today we'll look at AVG Logistics Limited (NSE:AVG) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting 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. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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'.
How Do You Calculate Return On Capital Employed?
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 AVG Logistics:
0.20 = ₹204m ÷ (₹1.7b - ₹735m) (Based on the trailing twelve months to March 2019.)
So, AVG Logistics has an ROCE of 20%.
View our latest analysis for AVG Logistics
Does AVG Logistics Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that AVG Logistics's ROCE is meaningfully better than the 16% average in the Transportation industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how AVG Logistics compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
AVG Logistics's current ROCE of 20% is lower than its ROCE in the past, which was 36%, 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how AVG Logistics's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is AVG Logistics? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do AVG Logistics'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. 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.