Why We’re Not Keen On Bonavista Energy Corporation’s (TSE:BNP) 3.0% Return On Capital

Today we’ll look at Bonavista Energy Corporation (TSE:BNP) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we’ll work out how to 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. Generally speaking a higher ROCE is better. 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 Bonavista Energy:

0.03 = CA$83m ÷ (CA$2.9b – CA$143m) (Based on the trailing twelve months to June 2019.)

So, Bonavista Energy has an ROCE of 3.0%.

Check out our latest analysis for Bonavista Energy

Is Bonavista Energy’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Bonavista Energy’s ROCE appears to be significantly below the 5.8% 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. Regardless of how Bonavista Energy stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.

Bonavista Energy delivered an ROCE of 3.0%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving.

TSX:BNP Past Revenue and Net Income, August 21st 2019
TSX:BNP Past Revenue and Net Income, August 21st 2019

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. ROCE is only a point-in-time measure. Remember that most companies like Bonavista Energy are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Bonavista Energy.

How Bonavista Energy’s Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Bonavista Energy has total assets of CA$2.9b and current liabilities of CA$143m. Therefore its current liabilities are equivalent to approximately 4.9% of its total assets. Bonavista Energy has a low level of current liabilities, which have a negligible impact on its already low ROCE.

What We Can Learn From Bonavista Energy’s ROCE

Nevertheless, there are potentially more attractive companies to invest in. You might be able to find a better investment than Bonavista Energy. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

I will like Bonavista 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.