Air Arabia PJSC (DFM:AIRARABIA) May Have Issues Allocating Its Capital

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. And from a first read, things don't look too good at Air Arabia PJSC (DFM:AIRARABIA), so let's see why.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Air Arabia PJSC is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.026 = د.إ250m ÷ (د.إ13b - د.إ2.9b) (Based on the trailing twelve months to September 2021).

So, Air Arabia PJSC has an ROCE of 2.6%. In absolute terms, that's a low return and it also under-performs the Airlines industry average of 3.9%.

See our latest analysis for Air Arabia PJSC

In the above chart we have measured Air Arabia PJSC's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Air Arabia PJSC here for free.

So How Is Air Arabia PJSC's ROCE Trending?

In terms of Air Arabia PJSC's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 5.5%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Air Arabia PJSC to turn into a multi-bagger.

What We Can Learn From Air Arabia PJSC's ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Yet despite these concerning fundamentals, the stock has performed strongly with a 41% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

While Air Arabia PJSC doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.