Today we’ll look at Seplat Petroleum Development Company Plc (LON:SEPL) 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.
First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.
So, How Do We Calculate ROCE?
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 Seplat Petroleum Development:
0.14 = US$111m ÷ (US$2.5b – US$298m) (Based on the trailing twelve months to September 2018.)
So, Seplat Petroleum Development has an ROCE of 14%.
View our latest analysis for Seplat Petroleum Development
Is Seplat Petroleum Development’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Seplat Petroleum Development’s ROCE appears to be substantially greater than the 4.8% average in the Oil and Gas industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how Seplat Petroleum Development compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Our data shows that Seplat Petroleum Development currently has an ROCE of 14%, compared to its ROCE of 9.2% 3 years ago. This makes us wonder if the company is improving.
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. ROCE is only a point-in-time measure. We note Seplat Petroleum Development could be considered a cyclical business. Since the future is so important for investors, you should check out our free report on analyst forecasts for Seplat Petroleum Development.
Do Seplat Petroleum Development’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Seplat Petroleum Development has total assets of US$2.5b and current liabilities of US$298m. Therefore its current liabilities are equivalent to approximately 12% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On Seplat Petroleum Development’s ROCE
Overall, Seplat Petroleum Development has a decent ROCE and could be worthy of further research. 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 Seplat Petroleum Development better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.