Today we'll look at High Arctic Energy Services Inc (TSE:HWO) and reflect on its potential as an investment. 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.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
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 High Arctic Energy Services:
0.022 = CA$5.1m ÷ (CA$258m - CA$24m) (Based on the trailing twelve months to June 2019.)
So, High Arctic Energy Services has an ROCE of 2.2%.
Is High Arctic Energy Services's ROCE Good?
One way to assess ROCE is to compare similar companies. We can see High Arctic Energy Services's ROCE is meaningfully below the Energy Services industry average of 7.2%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how High Arctic Energy Services compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.9% available in government bonds. It is likely that there are more attractive prospects out there.
We can see that , High Arctic Energy Services currently has an ROCE of 2.2%, less than the 26% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how High Arctic Energy Services'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 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. Given the industry it operates in, High Arctic Energy Services could be considered cyclical. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for High Arctic Energy Services.
How High Arctic Energy Services's Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
High Arctic Energy Services has total liabilities of CA$24m and total assets of CA$258m. As a result, its current liabilities are equal to approximately 9.1% of its total assets. High Arctic Energy Services has very few current liabilities, which have a minimal effect on its already low ROCE.
What We Can Learn From High Arctic Energy Services's ROCE
Still, investors could probably find more attractive prospects with better performance out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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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.