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Can Singapore Airlines Ltd Be A Winning Blue Chip Stock?

At the Motley Fool, we favor businesses with superior operations as they are the ones that can deliver long term returns for investors.

To figure out how well a business is run, we can look into a company’s return on equity (ROE). The ROE is a measure of how much profit a company generates for every shareholder dollar used in the business.

While the ROE is a good measure in itself, we can go a step further to gain even more insights. Breaking the ROE down into three other ratios may help us see how well a company is actually being managed.

Breaking up the ROE

In particular, we are looking to break down the ROE into three metrics, namely the return on sales, return on assets, and financial leverage.

ROE return on equity

With reference to the equation above, the first ratio (net income divided by sales) can be referred to as the return on sales, the second ratio (sales divided by assets) is the return on assets or asset turnover, and the third (assets divided by equity) is financial leverage.

For a succinct description of the individual elements, I turn to a passage from author and analyst Dennis Jean-Jacques’s book 5 Keys to Value Investing:

“Return on sales (ROS) indicates the amount of profits a company is able to keep for each dollar that the company takes in from the sale of goods and services. Asset turnover show the amount of revenues the company is able to generate for each dollar of assets committed. Financial leverage shows investors how many dollars of assets the firm can use for every dollar of equity.”

Putting Singapore Airlines to the test

Let’s run Singapore’s flagship carrier Singapore Airlines Ltd (SGX: C6L) through this exercise today.

Singapore Airlines is one of Singapore’s largest companies by market capitalisation and it can be considered as a blue chip stock by virtue of its status as one of the 30 components in the market benchmark the Straits Times Index (SGX: ^STI).

In the chart below, you can see how the three components of Singapore Airlines’ ROE have changed over the past five years:

SIA Singapore Airlines ROE Components

Source: Morningstar

First off, we can see that Singapore Airlines’ ROE has undergone a slight increase over the past five-plus years, moving from close to 1.6% in the financial year ended 31 March 2010 (FY2010) to a little over 2.7% in FY2014. While an increase is always nice to see, it’s worth noting that Singapore Airlines’ ROE over the timeframe under study has been really low.

When we dig into the components of the airline’s ROE, we may attribute the change in the financial metric to a marked increase in its return on sales (or net margin; this is denoted by the red line in the graph) and its asset turnover (see the orange line).

For a closer look at the asset turnover ratio, Singapore Airlines has been able to churn out an average of about 63 cents of revenue for each asset dollar employed over the past five years. Meanwhile, the airline has also been keeping its financial leverage steady at around 1.7 over the past five years (you can get a feel for this from the green line).

Overall, the company has not been able to generate a decent ROE as mentioned earlier. It is Singapore Airlines’ low net margins that has kept its ROE at those undesirable levels over its past five fiscal years.

A Fool’s take

A winning stock may be found when a company demonstrates a consistent track record of generating superior value for each shareholder dollar it has at its disposal.

In this case, Singapore Airlines has a lot to do if it wants to increase its ROE to higher levels. That may be tough since the airlines industry has traditionally been a tough space for any airline to carve out a sustainable advantage.

With that, the onus remains with the Foolish investor to decide if Singapore Airlines’ current share price provides an appropriate margin of safety and whether it fits into his or her portfolio.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.