What PrimeEnergy Resources' (NASDAQ:PNRG) Returns On Capital Can Tell Us

Simply Wall St
·3 min read

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. And from a first read, things don't look too good at PrimeEnergy Resources (NASDAQ:PNRG), so let's see why.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for PrimeEnergy Resources:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.049 = US$7.9m ÷ (US$229m - US$70m) (Based on the trailing twelve months to March 2020).

So, PrimeEnergy Resources has an ROCE of 4.9%. In absolute terms, that's a low return but it's around the Oil and Gas industry average of 6.0%.

See our latest analysis for PrimeEnergy Resources

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While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how PrimeEnergy Resources has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

The trend of ROCE at PrimeEnergy Resources is showing some signs of weakness. The company used to generate 16% on its capital five years ago but it has since fallen noticeably. In addition to that, PrimeEnergy Resources is now employing 29% less capital than it was five years ago. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. If these underlying trends continue, we wouldn't be too optimistic going forward.

On a side note, PrimeEnergy Resources' current liabilities have increased over the last five years to 30% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 4.9%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

The Key Takeaway

In summary, it's unfortunate that PrimeEnergy Resources is shrinking its capital base and also generating lower returns. Investors must expect better things on the horizon though because the stock has risen 39% in the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with PrimeEnergy Resources (including 1 which is is potentially serious) .

While PrimeEnergy Resources may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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