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Today we'll evaluate Ultra Petroleum Corp. (NASDAQ:UPL) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Ultra Petroleum:
0.13 = US$202m ÷ (US$1.8b - US$289m) (Based on the trailing twelve months to March 2019.)
So, Ultra Petroleum has an ROCE of 13%.
Is Ultra Petroleum's ROCE Good?
One way to assess ROCE is to compare similar companies. Ultra Petroleum's ROCE appears to be substantially greater than the 7.4% average in the Oil and Gas 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. Separate from Ultra Petroleum's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. We note Ultra Petroleum could be considered a cyclical business. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Ultra Petroleum's Current Liabilities Impact 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Ultra Petroleum has total liabilities of US$289m and total assets of US$1.8b. Therefore its current liabilities are equivalent to approximately 16% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On Ultra Petroleum's ROCE
This is good to see, and with a sound ROCE, Ultra Petroleum could be worth a closer look. There might be better investments than Ultra Petroleum out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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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 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.