Is Shandong Molong Petroleum Machinery Company Limited (HKG:568) Investing Effectively In Its Business?

Phillip Young

Wed, Feb 6, 2019, 8:13 PM

Today we’ll look at Shandong Molong Petroleum Machinery Company Limited (HKG:568) 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. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting 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. All else being equal, a better business will have a higher ROCE. 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 Shandong Molong Petroleum Machinery:

0.063 = -CN¥37.9m ÷ (CN¥6.3b – CN¥4.1b) (Based on the trailing twelve months to September 2018.)

So, Shandong Molong Petroleum Machinery has an ROCE of 6.3%.

View our latest analysis for Shandong Molong Petroleum Machinery

Does Shandong Molong Petroleum Machinery Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see Shandong Molong Petroleum Machinery’s ROCE is around the 6.3% average reported by the Energy Services industry. Separate from how Shandong Molong Petroleum Machinery stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.

In our analysis, Shandong Molong Petroleum Machinery’s ROCE appears to be 6.3%, compared to 3 years ago, when its ROCE was 0.9%. This makes us think the business might be improving.

It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. Remember that most companies like Shandong Molong Petroleum Machinery are cyclical businesses. If Shandong Molong Petroleum Machinery is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.