Today we are going to look at Woodside Petroleum Ltd (ASX:WPL) to see whether it might be an attractive investment prospect. 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.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is 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.'
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 Woodside Petroleum:
0.067 = US$1.9b ÷ (US$29b - US$1.0b) (Based on the trailing twelve months to June 2019.)
Therefore, Woodside Petroleum has an ROCE of 6.7%.
View our latest analysis for Woodside Petroleum
Is Woodside Petroleum's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Woodside Petroleum's ROCE appears to be significantly below the 9.9% average in the Oil and Gas industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Woodside Petroleum stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
Woodside Petroleum delivered an ROCE of 6.7%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability.
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 only a point-in-time measure. Given the industry it operates in, Woodside Petroleum could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Woodside Petroleum.
What Are Current Liabilities, And How Do They Affect Woodside Petroleum's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Woodside Petroleum has total liabilities of US$1.0b and total assets of US$29b. As a result, its current liabilities are equal to approximately 3.6% of its total assets. Woodside Petroleum has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
What We Can Learn From Woodside Petroleum's ROCE
If performance improves, then Woodside Petroleum may be an OK investment, especially at the right valuation. 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).
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.