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What Can We Make Of Kunlun Energy Company Limited’s (HKG:135) High Return On Capital?

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Today we'll look at Kunlun Energy Company Limited (HKG:135) 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.

First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its 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. 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'.

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 Kunlun Energy:

0.12 = CN¥12b ÷ (CN¥141b - CN¥39b) (Based on the trailing twelve months to December 2018.)

So, Kunlun Energy has an ROCE of 12%.

Check out our latest analysis for Kunlun Energy

Does Kunlun Energy Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Kunlun Energy's ROCE is meaningfully higher than the 10% average in the Oil and Gas industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Kunlun Energy sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Our data shows that Kunlun Energy currently has an ROCE of 12%, compared to its ROCE of 9.3% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.

SEHK:135 Past Revenue and Net Income, June 15th 2019
SEHK:135 Past Revenue and Net Income, June 15th 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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 only a point-in-time measure. Given the industry it operates in, Kunlun Energy could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Kunlun Energy.

How Kunlun Energy'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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Kunlun Energy has total liabilities of CN¥39b and total assets of CN¥141b. Therefore its current liabilities are equivalent to approximately 28% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

The Bottom Line On Kunlun Energy's ROCE

With that in mind, Kunlun Energy's ROCE appears pretty good. There might be better investments than Kunlun Energy 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.

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 editorial-team@simplywallst.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.