Examining Frontline Ltd.’s (NYSE:FRO) Weak Return On Capital Employed

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Today we are going to look at Frontline Ltd. (NYSE:FRO) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.

What is 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. Ultimately, it is a useful but imperfect metric. 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 Frontline:

0.045 = US$132m ÷ (US$3.1b – US$226m) (Based on the trailing twelve months to March 2019.)

So, Frontline has an ROCE of 4.5%.

View our latest analysis for Frontline

Does Frontline Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. We can see Frontline’s ROCE is meaningfully below the Oil and Gas industry average of 7.4%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Frontline stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.

Frontline’s current ROCE of 4.5% is lower than 3 years ago, when the company reported a 8.6% ROCE. Therefore we wonder if the company is facing new headwinds.

NYSE:FRO Past Revenue and Net Income, July 8th 2019
NYSE:FRO Past Revenue and Net Income, July 8th 2019

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, after all, simply a snap shot of a single year. Given the industry it operates in, Frontline could be considered cyclical. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How Frontline’s Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Frontline has total assets of US$3.1b and current liabilities of US$226m. Therefore its current liabilities are equivalent to approximately 7.3% of its total assets. Frontline has a low level of current liabilities, which have a negligible impact on its already low ROCE.

Our Take On Frontline’s ROCE

Nonetheless, there may be better places to invest your capital. You might be able to find a better investment than Frontline. 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).

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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.