Today we'll evaluate Bonterra Energy Corp. (TSE:BNE) to determine whether it could have potential as an investment idea. 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. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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'.
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 Bonterra Energy:
0.012 = CA$13m ÷ (CA$1.1b - CA$46m) (Based on the trailing twelve months to June 2019.)
Therefore, Bonterra Energy has an ROCE of 1.2%.
Does Bonterra Energy Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Bonterra Energy's ROCE is meaningfully below the Oil and Gas industry average of 5.9%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Bonterra Energy's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
Bonterra Energy has an ROCE of 1.2%, but it didn't have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving. The image below shows how Bonterra Energy's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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, after all, simply a snap shot of a single year. We note Bonterra Energy could be considered a cyclical business. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Bonterra Energy's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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.
Bonterra Energy has total assets of CA$1.1b and current liabilities of CA$46m. As a result, its current liabilities are equal to approximately 4.1% of its total assets. With barely any current liabilities, there is minimal impact on Bonterra Energy's admittedly low ROCE.
What We Can Learn From Bonterra Energy's ROCE
Nevertheless, there are potentially more attractive companies to invest in. Of course, you might also be able to find a better stock than Bonterra Energy. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.