Return on capital employed (ROCE) is a profitability ratio that measures how efficiently a company can generate profits from its capital employed by comparing net operating profit to capital employed.
The ratio works on the basic formula of:
ROCE = Profit before interest and tax (PBIT)/Capital employed
The ratio shows how much profit each dollar of employed capital generates. Obviously, a higher ratio would be more favorable because it means that more dollars of profits are generated by each dollar of capital employed.
ROCE is a long-term profitability ratio because it shows how effectively assets are performing while taking into consideration long-term financing.
Investors are interested in the ratio to see how efficiently a company uses its capital employed as well as its long-term financing strategies.
Tier One ROCE performance
In terms of ROCE, the best performing Tier One industrial gas company in Q4 2016 was Praxair, with a ratio of 13.9%. Air Products was a close second with 13.8%.
The average ROCE of all Tier One industrial gas companies slipped below 11% in Q4 2016. This is the lowest rate in recent years and the lowest percentage since before the recession. In fact, ROCE ratios have been experiencing a downward trend over the course of the last five years, with the highest average ratio not being in excess of 13% since Q3 2011.
Many factors can impact ROCE ratios, both favourably and unfavourably. One of the main determining factors is earnings before interest and tax (EBIT). In several recent financial quarters, the Tier One industrial gas companies have experienced flat to modest EBIT growth rates, which has naturally had a negative impact on ROCE. One key strategy that gas companies adopt to drive higher ROCE ratios, is to cut costs on capital employed.
This is the fourth in a series of articles that gets behind some of the business plans and accounting measures of the major industrial gas companies, and the industry itself.