Today we’ll look at Kinder Morgan, Inc. (NYSE:KMI) and reflect on its potential as an investment. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. 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. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 Kinder Morgan:
0.057 = US$3.9b ÷ (US$74b – US$5.6b) (Based on the trailing twelve months to March 2020.)
Therefore, Kinder Morgan has an ROCE of 5.7%.
Is Kinder Morgan’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Kinder Morgan’s ROCE appears to be significantly below the 7.7% average in 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. Aside from the industry comparison, Kinder Morgan’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
You can see in the image below how Kinder Morgan’s ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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 Kinder Morgan are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for Kinder Morgan.
Do Kinder Morgan’s Current Liabilities Skew 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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Kinder Morgan has total assets of US$74b and current liabilities of US$5.6b. Therefore its current liabilities are equivalent to approximately 7.6% of its total assets. Kinder Morgan has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
What We Can Learn From Kinder Morgan’s ROCE
Kinder Morgan looks like an ok business, but on this analysis it is not at the top of our buy list. 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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.