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Today we'll evaluate International Consolidated Airlines Group, S.A. (LON:IAG) 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. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from 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 International Consolidated Airlines Group:
0.20 = €3.3b ÷ (€28b - €11b) (Based on the trailing twelve months to December 2018.)
Therefore, International Consolidated Airlines Group has an ROCE of 20%.
Does International Consolidated Airlines Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In our analysis, International Consolidated Airlines Group's ROCE is meaningfully higher than the 15% average in the Airlines 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. Setting aside the comparison to its industry for a moment, International Consolidated Airlines Group's ROCE in absolute terms currently looks quite high.
In our analysis, International Consolidated Airlines Group's ROCE appears to be 20%, compared to 3 years ago, when its ROCE was 14%. This makes us think about whether the company has been reinvesting shrewdly.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for International Consolidated Airlines Group.
What Are Current Liabilities, And How Do They Affect International Consolidated Airlines Group's 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 counter this, investors can check if a company has high current liabilities relative to total assets.
International Consolidated Airlines Group has total liabilities of €11b and total assets of €28b. As a result, its current liabilities are equal to approximately 39% of its total assets. International Consolidated Airlines Group's ROCE is boosted somewhat by its middling amount of current liabilities.
The Bottom Line On International Consolidated Airlines Group's ROCE
Despite this, it reports a high ROCE, and may be worth investigating further. 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 International Consolidated Airlines Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 email@example.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.