Why We Like Brenntag AG’s (ETR:BNR) 11% Return On Capital Employed

Simply Wall St

Wed, Jun 5, 2019, 1:03 AM

Today we are going to look at Brenntag AG (ETR:BNR) 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. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

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. 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'.

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 Brenntag:

0.11 = €683m ÷ (€8.4b - €2.2b) (Based on the trailing twelve months to March 2019.)

So, Brenntag has an ROCE of 11%.

View our latest analysis for Brenntag

Is Brenntag's ROCE Good?

One way to assess ROCE is to compare similar companies. Brenntag's ROCE appears to be substantially greater than the 7.0% average in the Trade Distributors industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Brenntag's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

XTRA:BNR Past Revenue and Net Income, June 5th 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Brenntag's Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.