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Why Air New Zealand Limited’s (NZSE:AIR) Return On Capital Employed Looks Uninspiring

Simply Wall St

Today we'll look at Air New Zealand Limited (NZSE:AIR) and reflect on its potential as an investment. 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. 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 '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. 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?

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 Air New Zealand:

0.062 = NZ$315m ÷ (NZ$7.8b - NZ$2.7b) (Based on the trailing twelve months to June 2019.)

So, Air New Zealand has an ROCE of 6.2%.

Check out our latest analysis for Air New Zealand

Does Air New Zealand Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Air New Zealand's ROCE appears meaningfully below the 9.5% average reported by the Airlines industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Air New Zealand stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

Air New Zealand's current ROCE of 6.2% is lower than its ROCE in the past, which was 15%, 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how Air New Zealand's ROCE compares to its industry. Click to see more on past growth.

NZSE:AIR Past Revenue and Net Income, November 30th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during 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 Air New Zealand.

How Air New Zealand's Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Air New Zealand has total assets of NZ$7.8b and current liabilities of NZ$2.7b. Therefore its current liabilities are equivalent to approximately 34% of its total assets. Air New Zealand has a medium level of current liabilities, which would boost its ROCE somewhat.

Our Take On Air New Zealand's ROCE

Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. You might be able to find a better investment than Air New Zealand. 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).

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.