Why Energean Oil & Gas plc’s (LON:ENOG) Use Of Investor Capital Doesn’t Look Great

Today we'll evaluate Energean Oil & Gas plc (LON:ENOG) 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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 Energean Oil & Gas:

0.017 = US$24m ÷ (US$1.8b - US$386m) (Based on the trailing twelve months to December 2018.)

Therefore, Energean Oil & Gas has an ROCE of 1.7%.

See our latest analysis for Energean Oil & Gas

Does Energean Oil & Gas Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, Energean Oil & Gas's ROCE appears to be significantly below the 6.1% average in the Oil and Gas industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Energean Oil & Gas compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.2% available in government bonds. Readers may wish to look for more rewarding investments.

Energean Oil & Gas has an ROCE of 1.7%, but it didn't have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving.

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. We note Energean Oil & Gas could be considered a cyclical business. What happens in the future is pretty important for investors, so we have prepared a freereport on analyst forecasts for Energean Oil & Gas.

How Energean Oil & Gas's Current Liabilities Impact 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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.

Energean Oil & Gas has total liabilities of US$386m and total assets of US$1.8b. Therefore its current liabilities are equivalent to approximately 22% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.

What We Can Learn From Energean Oil & Gas's ROCE

That's not a bad thing, however Energean Oil & Gas has a weak ROCE and may not be an attractive investment. But note: Energean Oil & Gas may not be the best stock to buy. So take a peek at this freelist of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you are like me, then you will not want to miss this freelist 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.