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Today we’ll look at PetroChina Company Limited (HKG:857) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 PetroChina:
0.074 = CN¥82b ÷ (CN¥2.5t – CN¥624b) (Based on the trailing twelve months to September 2018.)
So, PetroChina has an ROCE of 7.4%.
Does PetroChina Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see PetroChina’s ROCE is meaningfully below the Oil and Gas industry average of 9.9%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Setting aside the industry comparison for now, PetroChina’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
As we can see, PetroChina currently has an ROCE of 7.4% compared to its ROCE 3 years ago, which was 5.0%. 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. 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 only a point-in-time measure. Given the industry it operates in, PetroChina 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 PetroChina.
How PetroChina’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 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.
PetroChina has total assets of CN¥2.5t and current liabilities of CN¥624b. Therefore its current liabilities are equivalent to approximately 25% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
Our Take On PetroChina’s ROCE
If PetroChina continues to earn an uninspiring ROCE, there may be better places to invest. But note: PetroChina may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 email@example.com.