Today we'll look at HollyFrontier Corporation (NYSE:HFC) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 HollyFrontier:
0.14 = US$1.5b ÷ (US$12b - US$1.7b) (Based on the trailing twelve months to September 2019.)
So, HollyFrontier has an ROCE of 14%.
Is HollyFrontier's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, HollyFrontier's ROCE is meaningfully higher than the 9.0% average in the Oil and Gas industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how HollyFrontier compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that, HollyFrontier currently has an ROCE of 14% compared to its ROCE 3 years ago, which was 5.0%. This makes us think the business might be improving. The image below shows how HollyFrontier's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. Remember that most companies like HollyFrontier are cyclical businesses. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
HollyFrontier's Current Liabilities And Their Impact On 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
HollyFrontier has total liabilities of US$1.7b and total assets of US$12b. Therefore its current liabilities are equivalent to approximately 14% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On HollyFrontier's ROCE
With that in mind, HollyFrontier's ROCE appears pretty good. HollyFrontier 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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