Is There More To Premier Oil plc (LON:PMO) Than Its 10.0% Returns On Capital?

Today we’ll look at Premier Oil plc (LON:PMO) 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.

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.

Understanding Return On Capital Employed (ROCE)

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.

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 Premier Oil:

0.10 = US$570m ÷ (US$6.3b – US$578m) (Based on the trailing twelve months to June 2019.)

So, Premier Oil has an ROCE of 10.0%.

Check out our latest analysis for Premier Oil

Does Premier Oil Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. It appears that Premier Oil’s ROCE is fairly close to the Oil and Gas industry average of 10%. Independently of how Premier Oil compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

The image below shows how Premier Oil’s ROCE compares to its industry, and you can click it to see more detail on its past growth.

LSE:PMO Past Revenue and Net Income, January 22nd 2020
LSE:PMO Past Revenue and Net Income, January 22nd 2020

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, after all, simply a snap shot of a single year. Remember that most companies like Premier Oil are cyclical businesses. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Premier Oil’s Current Liabilities And Their Impact On Its 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Premier Oil has total liabilities of US$578m and total assets of US$6.3b. Therefore its current liabilities are equivalent to approximately 9.2% of its total assets. With low current liabilities, Premier Oil’s decent ROCE looks that much more respectable.

The Bottom Line On Premier Oil’s ROCE

If it is able to keep this up, Premier Oil could be attractive. There might be better investments than Premier Oil out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.

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