Today we’ll evaluate Qantas Airways Limited (ASX:QAN) to determine whether it could have potential as an investment idea. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
What is 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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
So, How Do We Calculate ROCE?
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 Qantas Airways:
0.14 = AU$1.6b ÷ (AU$19b – AU$7.6b) (Based on the trailing twelve months to June 2018.)
Therefore, Qantas Airways has an ROCE of 14%.
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Does Qantas Airways Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Qantas Airways’s ROCE is around the 12% average reported by the Airlines industry. Independently of how Qantas Airways compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
In our analysis, Qantas Airways’s ROCE appears to be 14%, compared to 3 years ago, when its ROCE was 11%. This makes us think the business might be improving.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Qantas Airways.
Qantas Airways’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. 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.
Qantas Airways has total assets of AU$19b and current liabilities of AU$7.6b. Therefore its current liabilities are equivalent to approximately 41% of its total assets. Qantas Airways has a middling amount of current liabilities, increasing its ROCE somewhat.
Our Take On Qantas Airways’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. You might be able to find a better buy than Qantas Airways. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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.