Today we are going to look at RAK Petroleum plc (OB:RAKP) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.
How Do You Calculate Return On Capital Employed?
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 RAK Petroleum:
0.13 = US$426m ÷ (US$3.7b - US$317m) (Based on the trailing twelve months to June 2019.)
Therefore, RAK Petroleum has an ROCE of 13%.
Does RAK Petroleum Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, RAK Petroleum's ROCE appears to be around the 13% average of the Oil and Gas industry. Regardless of where RAK Petroleum sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
RAK Petroleum delivered an ROCE of 13%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how RAK Petroleum's past growth compares to other companies.
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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Given the industry it operates in, RAK Petroleum could be considered cyclical. You can check if RAK Petroleum has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect RAK Petroleum's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
RAK Petroleum has total assets of US$3.7b and current liabilities of US$317m. Therefore its current liabilities are equivalent to approximately 8.6% of its total assets. With low current liabilities, RAK Petroleum's decent ROCE looks that much more respectable.
The Bottom Line On RAK Petroleum's ROCE
This is good to see, and while better prospects may exist, RAK Petroleum seems worth researching further. RAK Petroleum looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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 firstname.lastname@example.org. 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.