Today we'll evaluate HollyFrontier Corporation (NYSE:HFC) to determine whether it could have potential as an investment idea. 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 up, we'll look at what ROCE is and how we calculate it. 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 measures the 'return' (pre-tax profit) a company generates from capital employed 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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
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 HollyFrontier:
0.16 = US$1.6b ÷ (US$12b - US$1.7b) (Based on the trailing twelve months to March 2019.)
So, HollyFrontier has an ROCE of 16%.
Is HollyFrontier's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, HollyFrontier's ROCE is meaningfully higher than the 7.4% average in the Oil and Gas industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where HollyFrontier 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 HollyFrontier currently has an ROCE of 16%, compared to its ROCE of 12% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how HollyFrontier'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. Given the industry it operates in, HollyFrontier could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for HollyFrontier.
Do HollyFrontier'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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
HollyFrontier has total liabilities of US$1.7b and total assets of US$12b. As a result, its current liabilities are equal to approximately 14% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On HollyFrontier's ROCE
Overall, HollyFrontier has a decent ROCE and could be worthy of further research. There might be better investments than HollyFrontier 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.
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