Today we’ll evaluate Enbridge Inc. (TSE:ENB) to determine whether it could have potential as an investment idea. 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. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 Enbridge:
0.046 = CA$6.9b ÷ (CA$167b – CA$15b) (Based on the trailing twelve months to December 2018.)
Therefore, Enbridge has an ROCE of 4.6%.
Is Enbridge’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Enbridge’s ROCE appears to be significantly below the 6.4% average in the Oil and Gas industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Enbridge stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.
In our analysis, Enbridge’s ROCE appears to be 4.6%, compared to 3 years ago, when its ROCE was 3.3%. This makes us think about whether the company has been reinvesting shrewdly.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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, after all, simply a snap shot of a single year. Remember that most companies like Enbridge are cyclical businesses. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Enbridge’s Current Liabilities And Their Impact On 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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Enbridge has total liabilities of CA$15b and total assets of CA$167b. As a result, its current liabilities are equal to approximately 8.9% of its total assets. Enbridge has a low level of current liabilities, which have a negligible impact on its already low ROCE.
What We Can Learn From Enbridge’s ROCE
Nonetheless, there may be better places to invest your capital. Of course, you might also be able to find a better stock than Enbridge. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Enbridge 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 firstname.lastname@example.org. 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.