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Should You Worry About Hallador Energy Company’s (NASDAQ:HNRG) ROCE?

Simply Wall St

Today we’ll look at Hallador Energy Company (NASDAQ:HNRG) 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.

First, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting 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. 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 Hallador Energy:

0.044 = US$26m ÷ (US$526m – US$50m) (Based on the trailing twelve months to September 2018.)

So, Hallador Energy has an ROCE of 4.4%.

Check out our latest analysis for Hallador Energy

Is Hallador Energy’s ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Hallador Energy’s ROCE appears meaningfully below the 8.5% average reported by the Oil and Gas industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. 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. Readers may wish to look for more rewarding investments.

Hallador Energy’s current ROCE of 4.4% is lower than 3 years ago, when the company reported a 11% ROCE. This makes us wonder if the business is facing new challenges.

NasdaqCM:HNRG Past Revenue and Net Income, March 4th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Remember that most companies like Hallador Energy are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for Hallador Energy.

How Hallador Energy’s Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Hallador Energy has total assets of US$526m and current liabilities of US$50m. Therefore its current liabilities are equivalent to approximately 9.5% of its total assets. With barely any current liabilities, there is minimal impact on Hallador Energy’s admittedly low ROCE.

What We Can Learn From Hallador Energy’s ROCE

Still, investors could probably find more attractive prospects with better performance out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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.