Today we’ll evaluate NRG Energy, Inc. (NYSE:NRG) 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 up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. 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 NRG Energy:
0.19 = US$1.2b ÷ (US$11b – US$2.7b) (Based on the trailing twelve months to September 2018.)
So, NRG Energy has an ROCE of 19%.
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Does NRG Energy Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that NRG Energy’s ROCE is meaningfully better than the 6.4% average in the Renewable Energy industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where NRG Energy sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
In our analysis, NRG Energy’s ROCE appears to be 19%, compared to 3 years ago, when its ROCE was 4.0%. This makes us think the business might be 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for NRG Energy.
Do NRG Energy’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 counter this, investors can check if a company has high current liabilities relative to total assets.
NRG Energy has total assets of US$11b and current liabilities of US$2.7b. As a result, its current liabilities are equal to approximately 24% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On NRG Energy’s ROCE
With that in mind, NRG Energy’s ROCE appears pretty good. You might be able to find a better buy than NRG Energy. 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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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.