U.S. Markets close in 4 hrs 4 mins

Are Sydney Airport Limited’s (ASX:SYD) High Returns Really That Great?

Simply Wall St

Today we are going to look at Sydney Airport Limited (ASX:SYD) 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.

First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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. 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. 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?

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 Sydney Airport:

0.075 = AU$883m ÷ (AU$13b - AU$841m) (Based on the trailing twelve months to June 2019.)

So, Sydney Airport has an ROCE of 7.5%.

See our latest analysis for Sydney Airport

Is Sydney Airport's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Sydney Airport's ROCE is meaningfully higher than the 5.5% average in the Infrastructure industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Aside from the industry comparison, Sydney Airport's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

The image below shows how Sydney Airport's ROCE compares to its industry, and you can click it to see more detail on its past growth.

ASX:SYD Past Revenue and Net Income, February 4th 2020

It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during 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 Sydney Airport.

Sydney Airport's Current Liabilities And Their Impact On Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Sydney Airport has total assets of AU$13b and current liabilities of AU$841m. As a result, its current liabilities are equal to approximately 6.7% of its total assets. With low levels of current liabilities, at least Sydney Airport's mediocre ROCE is not unduly boosted.

The Bottom Line On Sydney Airport's ROCE

If performance improves, then Sydney Airport may be an OK investment, especially at the right valuation. 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.

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. Thank you for reading.