Today we are going to look at Chorus Aviation Inc. (TSE:CHR) to see whether it might be an attractive investment prospect. 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. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
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 Chorus Aviation:
0.09 = CA$216m ÷ (CA$2.8b - CA$399m) (Based on the trailing twelve months to September 2019.)
So, Chorus Aviation has an ROCE of 9.0%.
Is Chorus Aviation's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Chorus Aviation's ROCE is around the 10.0% average reported by the Airlines industry. Separate from how Chorus Aviation stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
We can see that, Chorus Aviation currently has an ROCE of 9.0%, less than the 16% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Chorus Aviation's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Chorus Aviation.
Do Chorus Aviation's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Chorus Aviation has total liabilities of CA$399m and total assets of CA$2.8b. Therefore its current liabilities are equivalent to approximately 14% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
Our Take On Chorus Aviation's ROCE
That said, Chorus Aviation's ROCE is mediocre, there may be more attractive investments around. You might be able to find a better investment than Chorus Aviation. 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).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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