Why Apache Corporation’s (NYSE:APA) Return On Capital Employed Is Impressive
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Today we are going to look at Apache Corporation (NYSE:APA) to see whether it might be an attractive investment prospect. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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?
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 Apache:
0.11 = US$715m ÷ (US$22b – US$2.2b) (Based on the trailing twelve months to September 2018.)
Therefore, Apache has an ROCE of 11%.
See our latest analysis for Apache
Does Apache Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Apache’s ROCE appears to be substantially greater than the 6.2% 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. Aside from the industry comparison, Apache’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
Apache reported an ROCE of 11% — better than 3 years ago, when the company didn’t make a profit. That suggests the business has returned to profitability.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Remember that most companies like Apache are cyclical businesses. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do Apache’s Current Liabilities Skew 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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Apache has total assets of US$22b and current liabilities of US$2.2b. Therefore its current liabilities are equivalent to approximately 10% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From Apache’s ROCE
If Apache continues to earn an uninspiring ROCE, there may be better places to invest. Of course you might be able to find a better stock than Apache. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Apache better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
