InterGlobe Aviation (NSE:INDIGO) May Have Issues Allocating Its Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at InterGlobe Aviation (NSE:INDIGO), it didn't seem to tick all of these boxes.

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. Analysts use this formula to calculate it for InterGlobe Aviation:

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

0.037 = ₹9.5b ÷ (₹505b - ₹251b) (Based on the trailing twelve months to September 2022).

So, InterGlobe Aviation has an ROCE of 3.7%. Ultimately, that's a low return and it under-performs the Airlines industry average of 8.8%.

Our analysis indicates that INDIGO is potentially undervalued!

Above you can see how the current ROCE for InterGlobe Aviation 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 InterGlobe Aviation here for free.

The Trend Of ROCE

When we looked at the ROCE trend at InterGlobe Aviation, we didn't gain much confidence. Around five years ago the returns on capital were 17%, but since then they've fallen to 3.7%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, InterGlobe Aviation's current liabilities have increased over the last five years to 50% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

What We Can Learn From InterGlobe Aviation's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for InterGlobe Aviation. Furthermore the stock has climbed 54% over the last five years, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.

If you'd like to know about the risks facing InterGlobe Aviation, we've discovered 1 warning sign that you should be aware of.

While InterGlobe Aviation isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.