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When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. 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. So after glancing at the trends within Duty Free International (SGX:5SO), we weren't too hopeful.
What Is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Duty Free International is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.026 = RM12m ÷ (RM475m - RM22m) (Based on the trailing twelve months to November 2023).
Thus, Duty Free International has an ROCE of 2.6%. In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average of 12%.
Check out our latest analysis for Duty Free International
Historical performance is a great place to start when researching a stock so above you can see the gauge for Duty Free International's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Duty Free International.
What The Trend Of ROCE Can Tell Us
The trend of ROCE at Duty Free International is showing some signs of weakness. To be more specific, today's ROCE was 9.1% five years ago but has since fallen to 2.6%. What's equally concerning is that the amount of capital deployed in the business has shrunk by 26% over that same period. The fact that both are shrinking is an indication that the business is going through some tough times. If these underlying trends continue, we wouldn't be too optimistic going forward.
On a related note, Duty Free International has decreased its current liabilities to 4.5% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Key Takeaway
To see Duty Free International reducing the capital employed in the business in tandem with diminishing returns, is concerning. Long term shareholders who've owned the stock over the last five years have experienced a 41% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.