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Today we’ll look at Southwestern Energy Company (NYSE:SWN) and reflect on its potential as an investment. 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. 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. Generally speaking a higher ROCE is better. 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’.
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 Southwestern Energy:
0.13 = US$1.2b ÷ (US$7.1b – US$892m) (Based on the trailing twelve months to September 2018.)
So, Southwestern Energy has an ROCE of 13%.
Does Southwestern Energy Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Southwestern Energy’s ROCE is meaningfully higher 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. Regardless of where Southwestern Energy 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 Southwestern Energy currently has an ROCE of 13%, compared to its ROCE of 6.3% 3 years ago. This makes us wonder if the company is improving.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. We note Southwestern Energy 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 Southwestern Energy.
What Are Current Liabilities, And How Do They Affect Southwestern 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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Southwestern Energy has total liabilities of US$892m and total assets of US$7.1b. As a result, its current liabilities are equal to approximately 13% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On Southwestern Energy’s ROCE
With that in mind, Southwestern Energy’s ROCE appears pretty good. You might be able to find a better buy than Southwestern Energy. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like Southwestern Energy 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 firstname.lastname@example.org.