Today we'll evaluate California Resources Corporation (NYSE:CRC) to determine whether it could have potential as an investment idea. 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed 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?
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 California Resources:
0.09 = US$580m ÷ (US$7.0b - US$610m) (Based on the trailing twelve months to June 2019.)
Therefore, California Resources has an ROCE of 9.0%.
Is California Resources's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see California Resources's ROCE is around the 8.1% average reported by the Oil and Gas industry. Separate from how California Resources stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
California Resources has an ROCE of 9.0%, but it didn't have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving. The image below shows how California Resources'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. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Remember that most companies like California Resources are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for California Resources.
Do California Resources's Current Liabilities Skew 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. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.
California Resources has total liabilities of US$610m and total assets of US$7.0b. As a result, its current liabilities are equal to approximately 8.7% of its total assets. With low levels of current liabilities, at least California Resources's mediocre ROCE is not unduly boosted.
Our Take On California Resources's ROCE
California Resources looks like an ok business, but on this analysis it is not at the top of our buy list. Of course, you might also be able to find a better stock than California Resources. So you may wish to see this free collection of other companies that have grown earnings strongly.
California Resources is not the only stock insiders are buying. So take a peek at this free list of growing companies with 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 email@example.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.