Today we'll look at Kunlun Energy Company Limited (HKG:135) 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. 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. 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. 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 Kunlun Energy:

0.13 = CN¥13b ÷ (CN¥140b - CN¥38b) (Based on the trailing twelve months to June 2019.)

So, Kunlun Energy has an ROCE of 13%.

View our latest analysis for Kunlun Energy

Is Kunlun Energy's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Kunlun Energy's ROCE appears to be substantially greater than the 9.4% average in the Gas Utilities 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. Regardless of where Kunlun Energy sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Our data shows that Kunlun Energy currently has an ROCE of 13%, compared to its ROCE of 10.0% 3 years ago. This makes us think the business might be improving. You can see in the image below how Kunlun Energy's ROCE compares to its industry. Click to see more on past growth.

It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Kunlun Energy's Current Liabilities And Their Impact On 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.

Kunlun Energy has total liabilities of CN¥38b and total assets of CN¥140b. As a result, its current liabilities are equal to approximately 28% of its total assets. Low current liabilities are not boosting the ROCE too much.

The Bottom Line On Kunlun Energy's ROCE

This is good to see, and with a sound ROCE, Kunlun Energy could be worth a closer look. Kunlun Energy looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.

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