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Why You Should Care About BBA Aviation plc’s (LON:BBA) Low Return On Capital

Simply Wall St

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Today we'll look at BBA Aviation plc (LON:BBA) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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'.

How Do You Calculate Return On Capital Employed?

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 BBA Aviation:

0.068 = US$247m ÷ (US$4.3b - US$651m) (Based on the trailing twelve months to December 2018.)

Therefore, BBA Aviation has an ROCE of 6.8%.

See our latest analysis for BBA Aviation

Does BBA Aviation Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, BBA Aviation's ROCE appears to be significantly below the 11% average in the Infrastructure industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, BBA Aviation's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

LSE:BBA Past Revenue and Net Income, May 14th 2019

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. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do BBA Aviation's Current Liabilities Skew Its ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.

BBA Aviation has total liabilities of US$651m and total assets of US$4.3b. As a result, its current liabilities are equal to approximately 15% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

What We Can Learn From BBA Aviation's ROCE

That said, BBA Aviation's ROCE is mediocre, there may be more attractive investments around. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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

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.

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. Thank you for reading.