Today we'll look at TC Energy Corporation (TSE:TRP) and reflect on its potential as an investment. 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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 TC Energy:
0.071 = CA$6.3b ÷ (CA$100b - CA$11b) (Based on the trailing twelve months to September 2019.)
Therefore, TC Energy has an ROCE of 7.1%.
Check out our latest analysis for TC Energy
Is TC Energy's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, TC Energy's ROCE is meaningfully higher than the 5.3% average in the Oil and Gas industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from how TC Energy stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
We can see that, TC Energy currently has an ROCE of 7.1% compared to its ROCE 3 years ago, which was 4.7%. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how TC Energy's past growth compares to other companies.
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 TC Energy are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for TC Energy.
Do TC Energy's Current Liabilities Skew 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 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.
TC Energy has total liabilities of CA$11b and total assets of CA$100b. As a result, its current liabilities are equal to approximately 11% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From TC Energy's ROCE
With that in mind, we're not overly impressed with TC Energy's ROCE, so it may not be the most appealing prospect. Of course, you might also be able to find a better stock than TC Energy. So you may wish to see this free collection of other companies that have grown earnings strongly.
TC Energy is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider buying.
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.
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. Thank you for reading.
About TSX:TRP
Average dividend payer low.
