Today we'll look at Woodside Petroleum Ltd (ASX:WPL) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. 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?
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 Woodside Petroleum:
0.033 = US$938m ÷ (US$29b - US$1.1b) (Based on the trailing twelve months to December 2019.)
So, Woodside Petroleum has an ROCE of 3.3%.
Is Woodside Petroleum's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Woodside Petroleum's ROCE appears to be significantly below the 7.4% average in the Oil and Gas industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Woodside Petroleum stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
Woodside Petroleum's current ROCE of 3.3% is lower than 3 years ago, when the company reported a 5.4% ROCE. This makes us wonder if the business is facing new challenges. You can see in the image below how Woodside Petroleum's ROCE compares to its industry. Click to see more on 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 only a point-in-time measure. We note Woodside Petroleum 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 Woodside Petroleum.
Do Woodside Petroleum's Current Liabilities Skew 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.
Woodside Petroleum has current liabilities of US$1.1b and total assets of US$29b. Therefore its current liabilities are equivalent to approximately 3.9% of its total assets. With barely any current liabilities, there is minimal impact on Woodside Petroleum's admittedly low ROCE.
Our Take On Woodside Petroleum's ROCE
Nevertheless, there are potentially more attractive companies to invest in. 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.
I will like Woodside Petroleum better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.