Today we'll evaluate Qantas Airways Limited (ASX:QAN) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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.
So, How Do We Calculate ROCE?
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 Qantas Airways:
0.11 = AU$1.2b ÷ (AU$19b - AU$8.6b) (Based on the trailing twelve months to June 2019.)
So, Qantas Airways has an ROCE of 11%.
Is Qantas Airways's ROCE Good?
One way to assess ROCE is to compare similar companies. It appears that Qantas Airways's ROCE is fairly close to the Airlines industry average of 9.6%. Separate from Qantas Airways's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Qantas Airways's current ROCE of 11% is lower than 3 years ago, when the company reported a 15% ROCE. Therefore we wonder if the company is facing new headwinds. The image below shows how Qantas Airways's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Qantas Airways.
Qantas Airways's Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 current liabilities of AU$8.6b and total assets of AU$19b. Therefore its current liabilities are equivalent to approximately 44% of its total assets. Qantas Airways has a medium level of current liabilities, which would boost the ROCE.
What We Can Learn From Qantas Airways's ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. Qantas Airways shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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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