Why Kelt Exploration Ltd.’s (TSE:KEL) Use Of Investor Capital Doesn’t Look Great

Today we are going to look at Kelt Exploration Ltd. (TSE:KEL) 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.

First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.

Return On Capital Employed (ROCE): What is it?

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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’

So, How Do We Calculate ROCE?

Analysts use this formula to calculate return on capital employed:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)

Or for Kelt Exploration:

0.021 = CA$32m ÷ (CA$1.6b – CA$103m) (Based on the trailing twelve months to June 2019.)

Therefore, Kelt Exploration has an ROCE of 2.1%.

Check out our latest analysis for Kelt Exploration

Is Kelt Exploration’s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, Kelt Exploration’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. Putting aside Kelt Exploration’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.

Kelt Exploration has an ROCE of 2.1%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving.

TSX:KEL Past Revenue and Net Income, August 22nd 2019
TSX:KEL Past Revenue and Net Income, August 22nd 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Remember that most companies like Kelt Exploration are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Kelt Exploration.

Do Kelt Exploration’s Current Liabilities Skew Its ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.

Kelt Exploration has total assets of CA$1.6b and current liabilities of CA$103m. Therefore its current liabilities are equivalent to approximately 6.5% of its total assets. With barely any current liabilities, there is minimal impact on Kelt Exploration’s admittedly low ROCE.

What We Can Learn From Kelt Exploration’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 Kelt Exploration. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Kelt Exploration 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.