Does Woodside Petroleum Ltd’s (ASX:WPL) ROCE Reflect Well On The Business?
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Today we'll evaluate Woodside Petroleum Ltd (ASX:WPL) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we'll work out how to 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.
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. 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?
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 Woodside Petroleum:
0.084 = US$2.2b ÷ (US$27b - US$1.0b) (Based on the trailing twelve months to December 2018.)
Therefore, Woodside Petroleum has an ROCE of 8.4%.
Check out our latest analysis for Woodside Petroleum
Is Woodside Petroleum's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that Woodside Petroleum's ROCE is fairly close to the Oil and Gas industry average of 10%. Separate from how Woodside Petroleum stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
In our analysis, Woodside Petroleum's ROCE appears to be 8.4%, compared to 3 years ago, when its ROCE was 1.6%. This makes us think about whether the company has been reinvesting shrewdly.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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, after all, simply a snap shot of a single year. Remember that most companies like Woodside Petroleum are cyclical businesses. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Woodside Petroleum.
Woodside Petroleum's Current Liabilities And Their Impact On 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Woodside Petroleum has total liabilities of US$1.0b and total assets of US$27b. As a result, its current liabilities are equal to approximately 3.9% of its total assets. With low levels of current liabilities, at least Woodside Petroleum's mediocre ROCE is not unduly boosted.
What We Can Learn From Woodside Petroleum's ROCE
Woodside Petroleum looks like an ok business, but on this analysis it is not at the top of our buy list. Of course, you might also be able to find a better stock than Woodside Petroleum. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you are like me, then you will not want to miss this free list 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.
