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Why easyJet plc’s (LON:EZJ) Use Of Investor Capital Doesn’t Look Great

Simply Wall St

Today we are going to look at easyJet plc (LON:EZJ) to see whether it might be an attractive investment prospect. 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 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.

What is Return On Capital Employed (ROCE)?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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'.

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 easyJet:

0.067 = UK£301m ÷ (UK£7.4b - UK£2.9b) (Based on the trailing twelve months to March 2019.)

So, easyJet has an ROCE of 6.7%.

Check out our latest analysis for easyJet

Is easyJet's ROCE Good?

One way to assess ROCE is to compare similar companies. In this analysis, easyJet's ROCE appears meaningfully below the 14% average reported by the Airlines industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, easyJet'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.

We can see that, easyJet currently has an ROCE of 6.7%, less than the 22% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how easyJet's ROCE compares to its industry. Click to see more on past growth.

LSE:EZJ Past Revenue and Net Income, October 29th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for easyJet.

How easyJet's Current Liabilities Impact 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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

easyJet has total assets of UK£7.4b and current liabilities of UK£2.9b. As a result, its current liabilities are equal to approximately 39% of its total assets. easyJet has a medium level of current liabilities, which would boost its ROCE somewhat.

What We Can Learn From easyJet's ROCE

Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. 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.

easyJet is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider buying.

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.