Why We’re Not Keen On Whitecap Resources Inc.’s (TSE:WCP) 1.6% Return On Capital

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Today we’ll look at Whitecap Resources Inc. (TSE:WCP) and reflect on its potential as an investment. 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.

Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the 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.’

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 Whitecap Resources:

0.016 = CA$93m ÷ (CA$6.1b – CA$249m) (Based on the trailing twelve months to March 2019.)

So, Whitecap Resources has an ROCE of 1.6%.

See our latest analysis for Whitecap Resources

Does Whitecap Resources Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, Whitecap Resources’s ROCE appears to be significantly below the 5.5% average in the Oil and Gas industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Whitecap Resources compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.9% available in government bonds. It is likely that there are more attractive prospects out there.

Whitecap Resources has an ROCE of 1.6%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving.

TSX:WCP Past Revenue and Net Income, July 3rd 2019
TSX:WCP Past Revenue and Net Income, July 3rd 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. Given the industry it operates in, Whitecap Resources could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Whitecap Resources.

How Whitecap Resources’s Current Liabilities Impact Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Whitecap Resources has total liabilities of CA$249m and total assets of CA$6.1b. Therefore its current liabilities are equivalent to approximately 4.1% of its total assets. Whitecap Resources has very few current liabilities, which have a minimal effect on its already low ROCE.

The Bottom Line On Whitecap Resources’s ROCE

Still, investors could probably find more attractive prospects with better performance out there. You might be able to find a better investment than Whitecap Resources. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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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.