U.S. markets closed

Why Duty Free International Limited’s (SGX:5SO) Use Of Investor Capital Doesn’t Look Great

Simply Wall St

Today we'll evaluate Duty Free International Limited (SGX:5SO) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

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

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. Overall, it is a valuable metric that has its flaws. 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 Duty Free International:

0.064 = RM42m ÷ (RM827m - RM169m) (Based on the trailing twelve months to November 2019.)

So, Duty Free International has an ROCE of 6.4%.

View our latest analysis for Duty Free International

Does Duty Free International Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, Duty Free International's ROCE appears to be significantly below the 12% average in the Specialty Retail industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Setting aside the industry comparison for now, Duty Free International'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.

Duty Free International's current ROCE of 6.4% is lower than its ROCE in the past, which was 15%, 3 years ago. So investors might consider if it has had issues recently. The image below shows how Duty Free International's ROCE compares to its industry, and you can click it to see more detail on its past growth.

SGX:5SO Past Revenue and Net Income March 26th 2020

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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 only a point-in-time measure. You can check if Duty Free International has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Duty Free International's 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Duty Free International has total assets of RM827m and current liabilities of RM169m. Therefore its current liabilities are equivalent to approximately 20% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

The Bottom Line On Duty Free International's ROCE

With that in mind, we're not overly impressed with Duty Free International's ROCE, so it may not be the most appealing prospect. 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).

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.