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Today we’ll look at Canadian Natural Resources Limited (TSE:CNQ) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
What is 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. In general, businesses with a higher ROCE are usually better quality. 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 Canadian Natural Resources:
0.083 = CA$2.4b ÷ (CA$73b – CA$4.8b) (Based on the trailing twelve months to September 2018.)
So, Canadian Natural Resources has an ROCE of 8.3%.
Is Canadian Natural Resources’s ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, Canadian Natural Resources’s ROCE is meaningfully higher than the 4.9% average in the Oil and Gas industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Aside from the industry comparison, Canadian Natural Resources’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
In our analysis, Canadian Natural Resources’s ROCE appears to be 8.3%, compared to 3 years ago, when its ROCE was 2.6%. This makes us think about whether the company has been reinvesting shrewdly.
It is important to remember that ROCE shows past performance, and is 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. We note Canadian Natural Resources could be considered a cyclical business. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Canadian Natural Resources.
How Canadian Natural Resources’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. 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.
Canadian Natural Resources has total liabilities of CA$4.8b and total assets of CA$73b. As a result, its current liabilities are equal to approximately 6.5% of its total assets. Canadian Natural Resources has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
What We Can Learn From Canadian Natural Resources’s ROCE
Canadian Natural Resources looks like an ok business, but on this analysis it is not at the top of our buy list. But note: Canadian Natural Resources may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 email@example.com.