Today we’ll evaluate South Sea Petroleum Holdings Limited (HKG:76) 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.
Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business.
In general, businesses with a higher ROCE are usually better quality.
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?
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 South Sea Petroleum Holdings:
0.015 = -US$244.0k ÷ (US$443m – US$64m) (Based on the trailing twelve months to June 2018.)
So, South Sea Petroleum Holdings has an ROCE of 1.5%.
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Does South Sea Petroleum Holdings Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses.
In this analysis, South Sea Petroleum Holdings’s ROCE appears meaningfully below the 12% average reported by the Electronic industry.
This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors.
Regardless of how South Sea Petroleum Holdings stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account).
It is likely that there are more attractive prospects out there.
South Sea Petroleum Holdings delivered an ROCE of 1.5%, which is better than 3 years ago, as was making losses back then.
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.
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.
If South Sea Petroleum Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How South Sea Petroleum Holdings’s Current Liabilities Impact 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.
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 counter this, investors can check if a company has high current liabilities relative to total assets.
South Sea Petroleum Holdings has total liabilities of US$64m and total assets of US$443m.
Therefore its current liabilities are equivalent to approximately 14% of its total assets.
This is not a high level of current liabilities, which would not boost the ROCE by much.
What We Can Learn From South Sea Petroleum Holdings’s ROCE
South Sea Petroleum Holdings has a poor ROCE, and there may be better investment prospects out there.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
I will like South Sea Petroleum Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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 firstname.lastname@example.org.
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