Be Wary Of Air Arabia PJSC (DFM:AIRARABIA) And Its Returns On Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount 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. So after glancing at the trends within Air Arabia PJSC (DFM:AIRARABIA), we weren't too hopeful.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from 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)

0.0055 = د.إ53m ÷ (د.إ12b - د.إ2.9b) (Based on the trailing twelve months to June 2021).

Thus, Air Arabia PJSC has an ROCE of 0.5%. Even though it's in line with the industry average of 1.4%, it's still a low return by itself.

See our latest analysis for Air Arabia PJSC

Above you can see how the current ROCE for Air Arabia PJSC compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Air Arabia PJSC here for free.

What The Trend Of ROCE Can Tell Us

In terms of Air Arabia PJSC's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 6.3%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Air Arabia PJSC becoming one if things continue as they have.

The Bottom Line On Air Arabia PJSC's ROCE

In summary, it's unfortunate that Air Arabia PJSC is generating lower returns from the same amount of capital. In spite of that, the stock has delivered a 24% return to shareholders who held over the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

If you'd like to know about the risks facing Air Arabia PJSC, we've discovered 2 warning signs that you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.
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