Today we’ll look at Viva Energy Group Limited (ASX:VEA) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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?
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 Viva Energy Group:
0.14 = AU$370m ÷ (AU$4.8b – AU$2.1b) (Based on the trailing twelve months to December 2017.)
Therefore, Viva Energy Group has an ROCE of 14%.
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Is Viva Energy Group’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Viva Energy Group’s ROCE is meaningfully higher than the 6.5% average in the Oil and Gas industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Viva Energy Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Viva Energy Group delivered an ROCE of 14%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, Viva Energy Group 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 Viva Energy Group’s Current Liabilities Impact 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Viva Energy Group has total assets of AU$4.8b and current liabilities of AU$2.1b. Therefore its current liabilities are equivalent to approximately 44% of its total assets. With this level of current liabilities, Viva Energy Group’s ROCE is boosted somewhat.
Our Take On Viva Energy Group’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. But note: Viva Energy Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.