Experience Co: Returns on capital
I received a couple of comments on yesterday’s post on Experience Co (ASX:EXP) regarding my estimate of an 8-10% ROIC. I thought I would provide justification as to why I selected the measure I did and also provide some alternative measures of returns on capital employed.
How I calculated ROIC and why I selected that measure
To calculate ROIC I used normalised NPAT ($14.5m) divided by (equity plus net debt) ($208.7m) which works out to a ~7% ROIC in FY18. Adjusted for full year contribution of acquisitions I get around 8% ROIC at present.
I selected this metric for a couple of reasons. First because I think it is a more conservative measure of performance, and because I have assumed EXP does a substantial amount of acquiring.
For example if I buy a business for $100m, of which $50m is goodwill and $50m is tangible assets, and that business earns $10m NPAT a year, that’s a 10% return. It may be simplistic but for me it didn’t make sense to say “Well I’m actually earning a 20% return on tangible assets” on a business doing a lot of acquisitions like EXP. If I outlay $100m and I get $10m back each year = 10% return.
The second reason I selected ROIC is because I think that EXP will have to broaden its capabilities into buying or partnering with distributors like booking agents. While these may be acquired or there may be some sort of JV, these businesses don’t have any tangible assets. ROIC also accounts for debt which I think is important with a company like EXP.
However, it was pointed out to me that this type of ROIC is not a good measure of returns on organic reinvestment in the business (i.e., ROIIC), and I agree with that comment.
There are two other methods that were suggested to me today:
Returns On Tangible Capital
One suggestion I received was to calculate returns on tangible capital by taking EBITDA, minus depreciation, and dividing that by the tangible assets to get a sort of pre-tax, cash return on assets. This is useful for measuring potential returns on cash reinvested in the business. Formula:
(EBITDA minus maintenance capex) x (net assets minus intangible assets) = ROTC
Here is what this formula looks like in FY18 and using management’s FY19 numbers:
|EBITDA||Maint. capex||Net assets||Intangible assets||Tangible assets||ROTC|
*midpoint of management’s FY19 forecast
From this, EXP looks to be generating around a ~31% EBITA return on tangible assets, which suggests something like 20% ROTC after tax. This is quite credible and is a good argument for strong reinvestment in the business (noting also the numerous business opportunities identified) as opposed to just making acquisitions.
The Greenblatt magic formula
Another way of measuring returns on capital is the Greenblatt “magic formula”. This is calculated as:
EBIT divided by (working capital plus net fixed assets) = Greenblatt Return On Capital (ROC)
Here are the figures for FY18 & an estimate for FY19:
|EBIT||Working Capital*||Fixed Assets**||WC + FA||Greenblatt ROC|
|FY18||$12.2m||$5.6m||$121.5m||$127.1m||12.2 / 127.1 =||9.5%|
|FY19 est||$28m***||$9m (est)||$121.5m||$130.5m||28 / 130.5 =||21.4%|
*calculated as current assets minus current liabilities
**Using the property plant & equipment figure from EXP balance sheet
*** assuming $9m maintenance capex and $2m amortisation
The sharp improvement for FY19 is almost entirely due to full year contribution of acquired businesses, plus modest organic growth. I have made no adjustments for cash on the balance sheet in either the Greenblatt ROC or the ROTC above.
Food for thought.
I own shares in EXP. This is a disclosure and not a recommendation.