Returns On Capital Signal Difficult Times Ahead For Air New Zealand (NZSE:AIR)

What underlying fundamental trends can indicate that a company might be in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. And from a first read, things don't look too good at Air New Zealand (NZSE:AIR), so let's see why.

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 Air New Zealand, this is the formula:

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

0.042 = NZ$218m ÷ (NZ$8.8b - NZ$3.6b) (Based on the trailing twelve months to December 2024).

Thus, Air New Zealand has an ROCE of 4.2%. Ultimately, that's a low return and it under-performs the Airlines industry average of 8.9%.

See our latest analysis for Air New Zealand

In the above chart we have measured Air New Zealand's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Air New Zealand .

How Are Returns Trending?

There is reason to be cautious about Air New Zealand, given the returns are trending downwards. About five years ago, returns on capital were 5.4%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Air New Zealand to turn into a multi-bagger.

On a separate but related note, it's important to know that Air New Zealand 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

Our Take On Air New Zealand's ROCE

In summary, it's unfortunate that Air New Zealand is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 20% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

On a final note, we've found 2 warning signs for Air New Zealand that we think you should be aware of.

While Air New Zealand 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.