Yahoo Finance Petrofac Limited (LON:PFC) Earns Among The Best Returns In Its Industry
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Today we'll evaluate Petrofac Limited (LON:PFC) to determine whether it could have potential as an investment idea. 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
How Do You Calculate Return On Capital Employed?
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 Petrofac:
0.25 = US$507m ÷ (US$5.8b - US$3.8b) (Based on the trailing twelve months to December 2018.)
So, Petrofac has an ROCE of 25%.
Check out our latest analysis for Petrofac
Is Petrofac's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Petrofac's ROCE is meaningfully higher than the 11% average in the Energy Services industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, Petrofac's ROCE currently appears to be excellent.
As we can see, Petrofac currently has an ROCE of 25% compared to its ROCE 3 years ago, which was 2.4%. This makes us wonder if the company is improving.
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. ROCE is only a point-in-time measure. Given the industry it operates in, Petrofac could be considered cyclical. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Petrofac.
Do Petrofac's Current Liabilities Skew Its ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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.
Petrofac has total liabilities of US$3.8b and total assets of US$5.8b. As a result, its current liabilities are equal to approximately 65% of its total assets. Petrofac's high level of current liabilities boost the ROCE - but its ROCE is still impressive.
The Bottom Line On Petrofac's ROCE
So to us, the company is potentially worth investigating further. Petrofac looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
I will like Petrofac better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.
