Yahoo Finance What Can We Make Of Greggs plc’s (LON:GRG) High Return On Capital?
Today we'll look at Greggs plc (LON:GRG) and reflect on its potential as an investment. 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.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. 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.'
How Do You Calculate Return On Capital Employed?
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 Greggs:
0.18 = UK£108m ÷ (UK£760m - UK£178m) (Based on the trailing twelve months to June 2019.)
Therefore, Greggs has an ROCE of 19%.
See our latest analysis for Greggs
Does Greggs Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Greggs's ROCE is meaningfully better than the 7.9% average in the Hospitality industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where Greggs sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Greggs's current ROCE of 19% is lower than 3 years ago, when the company reported a 28% ROCE. However, we note that the lower ROCE is due to lease changes in the UK regarding the phasing in of IFRS16, which brings leases onto the balance sheet and effectively increases Gregg's total assets, versus its total assets three years ago. The image below shows how Greggs's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. 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 Greggs.
Greggs's Current Liabilities And Their Impact On 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Greggs has total assets of UK£760m and current liabilities of UK£178m. Therefore its current liabilities are equivalent to approximately 23% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Greggs's ROCE
Overall, Greggs has a decent ROCE and could be worthy of further research. Greggs looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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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.
