Here’s why Bonterra Energy Corp.’s (TSE:BNE) Returns On Capital Matters So Much

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Today we’ll look at Bonterra Energy Corp. (TSE:BNE) 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, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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 Bonterra Energy:

0.02 = CA$22m ÷ (CA$1.1b – CA$54m) (Based on the trailing twelve months to March 2019.)

So, Bonterra Energy has an ROCE of 2.0%.

See our latest analysis for Bonterra Energy

Is Bonterra Energy’s ROCE Good?

One way to assess ROCE is to compare similar companies. We can see Bonterra Energy’s ROCE is meaningfully below the Oil and Gas industry average of 5.5%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Bonterra Energy compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.9% available in government bonds. There are potentially more appealing investments elsewhere.

As we can see, Bonterra Energy currently has an ROCE of 2.0% compared to its ROCE 3 years ago, which was 0.4%. This makes us think about whether the company has been reinvesting shrewdly.

TSX:BNE Past Revenue and Net Income, June 24th 2019
TSX:BNE Past Revenue and Net Income, June 24th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. Remember that most companies like Bonterra Energy are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for Bonterra Energy.

What Are Current Liabilities, And How Do They Affect Bonterra Energy’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.

Bonterra Energy has total assets of CA$1.1b and current liabilities of CA$54m. As a result, its current liabilities are equal to approximately 4.8% of its total assets. With barely any current liabilities, there is minimal impact on Bonterra Energy’s admittedly low ROCE.

What We Can Learn From Bonterra Energy’s ROCE

Nonetheless, there may be better places to invest your capital. 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.

I will like Bonterra Energy better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.