Here's What's Concerning About Deutsche Lufthansa's (ETR:LHA) 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. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after glancing at the trends within Deutsche Lufthansa (ETR:LHA), we weren't too hopeful.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Deutsche Lufthansa, this is the formula:

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

0.093 = €2.3b ÷ (€45b - €21b) (Based on the trailing twelve months to June 2023).

So, Deutsche Lufthansa has an ROCE of 9.3%. In absolute terms, that's a low return and it also under-performs the Airlines industry average of 14%.

View our latest analysis for Deutsche Lufthansa

In the above chart we have measured Deutsche Lufthansa'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 Deutsche Lufthansa here for free.

How Are Returns Trending?

In terms of Deutsche Lufthansa's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 13% that they were earning five years ago. 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. If these trends continue, we wouldn't expect Deutsche Lufthansa to turn into a multi-bagger.

On a side note, Deutsche Lufthansa's current liabilities are still rather high at 46% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Key Takeaway

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. Investors haven't taken kindly to these developments, since the stock has declined 49% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One more thing, we've spotted 1 warning sign facing Deutsche Lufthansa that you might find interesting.

While Deutsche Lufthansa may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.