Do Tourmaline Oil Corp.’s (TSE:TOU) Returns On Capital Employed Make The Cut?

Today we’ll look at Tourmaline Oil Corp. (TSE:TOU) 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. 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. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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?

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 Tourmaline Oil:

0.054 = CA$558m ÷ (CA$11b – CA$581m) (Based on the trailing twelve months to March 2019.)

Therefore, Tourmaline Oil has an ROCE of 5.4%.

View our latest analysis for Tourmaline Oil

Does Tourmaline Oil Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see Tourmaline Oil’s ROCE is around the 5.5% average reported by the Oil and Gas industry. Aside from the industry comparison, Tourmaline Oil’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

Our data shows that Tourmaline Oil currently has an ROCE of 5.4%, compared to its ROCE of 1.1% 3 years ago. This makes us think the business might be improving.

TSX:TOU Past Revenue and Net Income, July 24th 2019
TSX:TOU Past Revenue and Net Income, July 24th 2019

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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. Given the industry it operates in, Tourmaline Oil could be considered cyclical. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Tourmaline Oil.

What Are Current Liabilities, And How Do They Affect Tourmaline Oil’s 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Tourmaline Oil has total liabilities of CA$581m and total assets of CA$11b. Therefore its current liabilities are equivalent to approximately 5.3% of its total assets. Tourmaline Oil reports few current liabilities, which have a negligible impact on its unremarkable ROCE.

Our Take On Tourmaline Oil’s ROCE

Tourmaline Oil looks like an ok business, but on this analysis it is not at the top of our buy list. 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 Tourmaline Oil 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.