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Should You Worry About Duty Free International Limited’s (SGX:5SO) ROCE?

Simply Wall St

Today we'll look at Duty Free International Limited (SGX:5SO) and reflect on its potential as an investment. 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.

Firstly, 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 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. Ultimately, it is a useful but imperfect metric. 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?

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:

0.068 = RM46m ÷ (RM757m - RM89m) (Based on the trailing twelve months to August 2019.)

So, Duty Free International has an ROCE of 6.8%.

See our latest analysis for Duty Free International

Is Duty Free International's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Duty Free International's ROCE appears to be significantly below the 9.6% average in the Specialty Retail industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Duty Free International stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.

Duty Free International's current ROCE of 6.8% is lower than 3 years ago, when the company reported a 17% ROCE. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Duty Free International's past growth compares to other companies.

SGX:5SO Past Revenue and Net Income, October 11th 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. How cyclical is Duty Free International? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Duty Free International's Current Liabilities And Their Impact On Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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.

Duty Free International has total liabilities of RM89m and total assets of RM757m. As a result, its current liabilities are equal to approximately 12% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

Our Take On Duty Free International's ROCE

If Duty Free International continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might also be able to find a better stock than Duty Free International. So you may wish to see this free collection of other companies that have grown earnings strongly.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.