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Has Mercury NZ Limited (NZSE:MCY) Been Employing Capital Shrewdly?

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Today we are going to look at Mercury NZ Limited (NZSE:MCY) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Return On Capital Employed (ROCE): What is it?

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. In brief, it is a useful tool, but it is not without drawbacks. 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:

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

Or for Mercury NZ:

0.063 = NZ$356m ÷ (NZ$6.2b - NZ$583m) (Based on the trailing twelve months to December 2018.)

So, Mercury NZ has an ROCE of 6.3%.

Check out our latest analysis for Mercury NZ

Is Mercury NZ's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Mercury NZ's ROCE appears to be around the 6.3% average of the Electric Utilities industry. Setting aside the industry comparison for now, Mercury NZ's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

NZSE:MCY Past Revenue and Net Income, June 10th 2019
NZSE:MCY Past Revenue and Net Income, June 10th 2019

When considering this metric, keep in mind that it is backwards looking, and 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Mercury NZ.

Do Mercury NZ's Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Mercury NZ has total liabilities of NZ$583m and total assets of NZ$6.2b. Therefore its current liabilities are equivalent to approximately 9.4% of its total assets. With low levels of current liabilities, at least Mercury NZ's mediocre ROCE is not unduly boosted.

The Bottom Line On Mercury NZ's ROCE

If performance improves, then Mercury NZ may be an OK investment, especially at the right valuation. You might be able to find a better investment than Mercury NZ. 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 Mercury NZ better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.