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Here’s why Singapore Airlines Limited’s (SGX:C6L) Returns On Capital Matters So Much

Simply Wall St

Today we'll look at Singapore Airlines Limited (SGX:C6L) 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. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

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. 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.

How Do You Calculate Return On Capital Employed?

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 Singapore Airlines:

0.045 = S$1.1b ÷ (S$32b - S$8.1b) (Based on the trailing twelve months to June 2019.)

Therefore, Singapore Airlines has an ROCE of 4.5%.

View our latest analysis for Singapore Airlines

Does Singapore Airlines Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Singapore Airlines's ROCE appears to be significantly below the 7.5% average in the Airlines industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Singapore Airlines stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.

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

SGX:C6L Past Revenue and Net Income, November 7th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Singapore Airlines.

What Are Current Liabilities, And How Do They Affect Singapore Airlines's ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Singapore Airlines has total assets of S$32b and current liabilities of S$8.1b. As a result, its current liabilities are equal to approximately 25% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.

What We Can Learn From Singapore Airlines's ROCE

Singapore Airlines has a poor ROCE, and there may be better investment prospects out there. 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 are like me, then you will not want to miss this free list of growing companies that insiders are 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.