Are Enerplus Corporation’s (TSE:ERF) High Returns Really That Great?

Today we’ll evaluate Enerplus Corporation (TSE:ERF) to determine whether it could have potential as an investment idea. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared 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 measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 Enerplus:

0.22 = CA$563m ÷ (CA$3.1b – CA$475m) (Based on the trailing twelve months to June 2019.)

So, Enerplus has an ROCE of 22%.

View our latest analysis for Enerplus

Is Enerplus’s ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. Enerplus’s ROCE appears to be substantially greater than the 5.9% average in the Oil and Gas industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, Enerplus’s ROCE is currently very good.

Enerplus has an ROCE of 22%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving.

TSX:ERF Past Revenue and Net Income, August 29th 2019
TSX:ERF Past Revenue and Net Income, August 29th 2019

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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. Remember that most companies like Enerplus are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for Enerplus.

How Enerplus’s Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Enerplus has total assets of CA$3.1b and current liabilities of CA$475m. Therefore its current liabilities are equivalent to approximately 15% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.

Our Take On Enerplus’s ROCE

This is good to see, and with such a high ROCE, Enerplus may be worth a closer look. There might be better investments than Enerplus out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

There are plenty of other companies that have insiders buying up shares. You probably do not want to miss this free list of growing companies that insiders are 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.