Why We’re Not Keen On Panhandle Oil and Gas Inc.’s (NYSE:PHX) 3.5% Return On Capital

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Today we’ll look at Panhandle Oil and Gas Inc. (NYSE:PHX) 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. 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 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. 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?

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 Panhandle Oil and Gas:

0.035 = US$7.2m ÷ (US$206m – US$1.9m) (Based on the trailing twelve months to March 2019.)

Therefore, Panhandle Oil and Gas has an ROCE of 3.5%.

View our latest analysis for Panhandle Oil and Gas

Is Panhandle Oil and Gas’s ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, Panhandle Oil and Gas’s ROCE appears to be significantly below the 7.4% average in the Oil and Gas industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Panhandle Oil and Gas compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. There are potentially more appealing investments elsewhere.

Panhandle Oil and Gas reported an ROCE of 3.5% — better than 3 years ago, when the company didn’t make a profit. That implies the business has been improving.

NYSE:PHX Past Revenue and Net Income, July 4th 2019
NYSE:PHX Past Revenue and Net Income, July 4th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. Remember that most companies like Panhandle Oil and Gas are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Panhandle Oil and Gas.

Panhandle Oil and Gas’s Current Liabilities And Their Impact On 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. 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.

Panhandle Oil and Gas has total liabilities of US$1.9m and total assets of US$206m. Therefore its current liabilities are equivalent to approximately 0.9% of its total assets. Panhandle Oil and Gas has a low level of current liabilities, which have a negligible impact on its already low ROCE.

The Bottom Line On Panhandle Oil and Gas’s ROCE

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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.