A Close Look At I G Petrochemicals Limited’s (NSE:IGPL) 24% ROCE

Simply Wall St

Tue, Jun 18, 2019, 7:45 PM

Today we are going to look at I G Petrochemicals Limited (NSE:IGPL) to see whether it might be an attractive investment prospect. 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. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

What is 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. Overall, it is a valuable metric that has its flaws. 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 I G Petrochemicals:

0.24 = ₹2.0b ÷ (₹12b - ₹3.3b) (Based on the trailing twelve months to March 2019.)

So, I G Petrochemicals has an ROCE of 24%.

See our latest analysis for I G Petrochemicals

Is I G Petrochemicals's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that I G Petrochemicals's ROCE is meaningfully better than the 17% average in the Chemicals industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how I G Petrochemicals compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

NSEI:IGPL Past Revenue and Net Income, June 19th 2019

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for I G Petrochemicals.

What Are Current Liabilities, And How Do They Affect I G Petrochemicals's 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.