What Do The Returns On Capital At International Consolidated Airlines Group (LON:IAG) Tell Us?

By
Simply Wall St
Published
August 03, 2020
LSE:IAG

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at International Consolidated Airlines Group (LON:IAG) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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 International Consolidated Airlines Group is:

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

0.017 = €312m ÷ (€32b - €13b) (Based on the trailing twelve months to June 2020).

Therefore, International Consolidated Airlines Group has an ROCE of 1.7%. Ultimately, that's a low return and it under-performs the Airlines industry average of 12%.

See our latest analysis for International Consolidated Airlines Group

roce
LSE:IAG Return on Capital Employed August 3rd 2020

Above you can see how the current ROCE for International Consolidated Airlines Group 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 International Consolidated Airlines Group here for free.

What Does the ROCE Trend For International Consolidated Airlines Group Tell Us?

The trend of ROCE doesn't look fantastic because it's fallen from 12% five years ago, while the business's capital employed increased by 22%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. It's unlikely that all of the funds raised have been put to work yet, so as a consequence International Consolidated Airlines Group might not have received a full period of earnings contribution from it.

On a separate but related note, it's important to know that International Consolidated Airlines Group has a current liabilities to total assets ratio of 41%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

Our Take On International Consolidated Airlines Group's ROCE

In summary, we're somewhat concerned by International Consolidated Airlines Group's diminishing returns on increasing amounts of capital. It should come as no surprise then that the stock has fallen 63% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

International Consolidated Airlines Group does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those shouldn't be ignored...

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. 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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