Today we'll evaluate Deutsche Lufthansa AG (ETR:LHA) to determine whether it could have potential as an investment idea. 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. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
So, How Do We Calculate ROCE?
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 Deutsche Lufthansa:
0.071 = €1.9b ÷ (€44b - €18b) (Based on the trailing twelve months to September 2019.)
So, Deutsche Lufthansa has an ROCE of 7.1%.
Does Deutsche Lufthansa Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Deutsche Lufthansa's ROCE appears meaningfully below the 10% average reported by the Airlines industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Deutsche Lufthansa stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
You can see in the image below how Deutsche Lufthansa's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Deutsche Lufthansa.
Do Deutsche Lufthansa's Current Liabilities Skew 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Deutsche Lufthansa has total assets of €44b and current liabilities of €18b. Therefore its current liabilities are equivalent to approximately 40% of its total assets. Deutsche Lufthansa's ROCE is improved somewhat by its moderate amount of current liabilities.
Our Take On Deutsche Lufthansa's ROCE
Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. Of course, you might also be able to find a better stock than Deutsche Lufthansa. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Deutsche Lufthansa better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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