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When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. On that note, looking into Deutsche Lufthansa (ETR:LHA), we weren't too upbeat about how things were going.
Return On Capital Employed (ROCE): What Is It?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Deutsche Lufthansa, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.043 = €1.1b ÷ (€47b - €22b) (Based on the trailing twelve months to June 2024).
Therefore, Deutsche Lufthansa has an ROCE of 4.3%. In absolute terms, that's a low return and it also under-performs the Airlines industry average of 9.9%.
See our latest analysis for Deutsche Lufthansa
In the above chart we have measured Deutsche Lufthansa's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Deutsche Lufthansa for free.
The Trend Of ROCE
There is reason to be cautious about Deutsche Lufthansa, given the returns are trending downwards. About five years ago, returns on capital were 7.7%, 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. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Deutsche Lufthansa to turn into a multi-bagger.
On a side note, Deutsche Lufthansa's current liabilities are still rather high at 47% of total assets. 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.
The Bottom Line On Deutsche Lufthansa's ROCE
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors haven't taken kindly to these developments, since the stock has declined 37% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.