Today we are going to look at Public Joint Stock Company Aeroflot - Russian Airlines (MCX:AFLT) to see whether it might be an attractive investment prospect. 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.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting 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. Ultimately, it is a useful but imperfect metric. 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 Aeroflot - Russian Airlines:
0.024 = ₽17b ÷ (₽977b - ₽274b) (Based on the trailing twelve months to June 2019.)
So, Aeroflot - Russian Airlines has an ROCE of 2.4%.
Does Aeroflot - Russian Airlines Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Aeroflot - Russian Airlines's ROCE is meaningfully below the Airlines industry average of 10%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Aeroflot - Russian Airlines stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.
We can see that, Aeroflot - Russian Airlines currently has an ROCE of 2.4%, less than the 41% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Aeroflot - Russian Airlines's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is 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. 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 Aeroflot - Russian Airlines.
Do Aeroflot - Russian Airlines's Current Liabilities Skew 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. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Aeroflot - Russian Airlines has total assets of ₽977b and current liabilities of ₽274b. As a result, its current liabilities are equal to approximately 28% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
What We Can Learn From Aeroflot - Russian Airlines's ROCE
Aeroflot - Russian Airlines has a poor ROCE, and there may be better investment prospects out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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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