Today we’ll look at Denbury Resources Inc. (NYSE:DNR) and reflect on its potential as an investment. 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. 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 is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 Denbury Resources:
0.062 = US$146m ÷ (US$4.6b – US$526m) (Based on the trailing twelve months to September 2018.)
So, Denbury Resources has an ROCE of 6.2%.
Is Denbury Resources’s ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Denbury Resources’s ROCE appears to be around the 5.6% average of the Oil and Gas industry. Separate from how Denbury 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.
Denbury Resources’s current ROCE of 6.2% is lower than its ROCE in the past, which was 9.2%, 3 years ago. So investors might consider if it has had issues recently.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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 Denbury Resources are cyclical businesses. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Denbury Resources’s Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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.
Denbury Resources has total assets of US$4.6b and current liabilities of US$526m. As a result, its current liabilities are equal to approximately 11% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
What We Can Learn From Denbury Resources’s ROCE
If Denbury Resources continues to earn an uninspiring ROCE, there may be better places to invest. But note: Denbury Resources may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
I will like Denbury Resources better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.