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Is The Hong Kong and China Gas Company Limited (HKG:3) Struggling With Its 7.0% Return On Capital Employed?

Today we'll look at The Hong Kong and China Gas Company Limited (HKG:3) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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?

Analysts use this formula to calculate return on capital employed:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Hong Kong and China Gas:

0.07 = HK$8.0b ÷ (HK$140b - HK$26b) (Based on the trailing twelve months to December 2019.)

Therefore, Hong Kong and China Gas has an ROCE of 7.0%.

Check out our latest analysis for Hong Kong and China Gas

Is Hong Kong and China Gas's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Hong Kong and China Gas's ROCE appears to be significantly below the 9.1% average in the Gas Utilities industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Hong Kong and China Gas stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.

You can see in the image below how Hong Kong and China Gas's ROCE compares to its industry. Click to see more on past growth.

SEHK:3 Past Revenue and Net Income May 25th 2020
SEHK:3 Past Revenue and Net Income May 25th 2020

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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Hong Kong and China Gas.

Hong Kong and China Gas's Current Liabilities And Their Impact On 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.

Hong Kong and China Gas has total assets of HK$140b and current liabilities of HK$26b. Therefore its current liabilities are equivalent to approximately 19% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

The Bottom Line On Hong Kong and China Gas's ROCE

If Hong Kong and China Gas continues to earn an uninspiring ROCE, there may be better places to invest. You might be able to find a better investment than Hong Kong and China Gas. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

I will like Hong Kong and China Gas better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.