Why Air Lease Corporation’s (NYSE:AL) Return On Capital Employed Might Be A Concern

Today we’ll look at Air Lease Corporation (NYSE:AL) 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. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.

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 Air Lease:

0.055 = US$897m ÷ (US$18b – US$310m) (Based on the trailing twelve months to September 2018.)

Therefore, Air Lease has an ROCE of 5.5%.

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Does Air Lease Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Air Lease’s ROCE appears meaningfully below the 7.9% average reported by 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. Putting aside Air Lease’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.

NYSE:AL Last Perf January 21st 19
NYSE:AL Last Perf January 21st 19

It is important to remember that ROCE shows past performance, and is 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Air Lease.

Air Lease’s Current Liabilities And Their Impact On Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.

Air Lease has total liabilities of US$310m and total assets of US$18b. As a result, its current liabilities are equal to approximately 1.8% of its total assets. Air Lease has very few current liabilities, which have a minimal effect on its already low ROCE.

Our Take On Air Lease’s ROCE

Nevertheless, there are potentially more attractive companies to invest in. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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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 editorial-team@simplywallst.com.