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Today we’ll look at CNOOC Limited (HKG:883) and reflect on its potential as an investment. 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 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. 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?
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 CNOOC:
0.092 = CN¥35b ÷ (CN¥653b – CN¥69b) (Based on the trailing twelve months to June 2018.)
Therefore, CNOOC has an ROCE of 9.2%.
See our latest analysis for CNOOC
Does CNOOC Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, CNOOC’s ROCE appears to be around the 9.9% average of the Oil and Gas industry. Separate from how CNOOC 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.
Our data shows that CNOOC currently has an ROCE of 9.2%, compared to its ROCE of 7.2% 3 years ago. 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. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. We note CNOOC could be considered a cyclical business. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for CNOOC.
What Are Current Liabilities, And How Do They Affect CNOOC’s ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.