Today we are going to look at Hallador Energy Company (NASDAQ:HNRG) to see whether it might be an attractive investment prospect. 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
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?
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 Hallador Energy:
0.051 = US$23m ÷ (US$513m - US$61m) (Based on the trailing twelve months to June 2019.)
So, Hallador Energy has an ROCE of 5.1%.
Is Hallador Energy's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Hallador Energy's ROCE is meaningfully below the Oil and Gas industry average of 7.9%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Hallador 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.
Hallador Energy's current ROCE of 5.1% is lower than 3 years ago, when the company reported a 8.0% ROCE. This makes us wonder if the business is facing new challenges. You can see in the image below how Hallador Energy's ROCE compares to its industry. Click to see more on 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 only a point-in-time measure. Given the industry it operates in, Hallador Energy could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Hallador Energy.
Do Hallador Energy's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Hallador Energy has total liabilities of US$61m and total assets of US$513m. As a result, its current liabilities are equal to approximately 12% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
The Bottom Line On Hallador Energy's ROCE
That's not a bad thing, however Hallador Energy has a weak ROCE and may not be an attractive investment. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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.