Today we’ll look at Willis Lease Finance Corporation (NASDAQ:WLFC) and reflect on its potential as an investment. 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.
First up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Willis Lease Finance:
0.054 = US$98m ÷ (US$2.0b – US$130m) (Based on the trailing twelve months to September 2018.)
So, Willis Lease Finance has an ROCE of 5.4%.
Does Willis Lease Finance Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, Willis Lease Finance’s ROCE appears to be significantly below the 7.9% average in the Trade Distributors industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Willis Lease Finance stacks up against its industry, its ROCE in absolute terms is quite low (not much higher than a bank account). It is likely that there are more attractive prospects out there.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. If Willis Lease Finance is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Willis Lease Finance’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Willis Lease Finance has total assets of US$2.0b and current liabilities of US$130m. Therefore its current liabilities are equivalent to approximately 6.6% of its total assets. Willis Lease Finance has a low level of current liabilities, which have a negligible impact on its already low ROCE.
What We Can Learn From Willis Lease Finance’s ROCE
Still, investors could probably find more attractive prospects with better performance out there. We prefer to see a high ROCE, but even a low quality business can be a good buy at the right price. So it might be wise to check if insiders have been buying.
Of course Willis Lease Finance may not be the best stock to buy. So you may wish to see this free collection of other companies that have high ROE and low debt.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.