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1 Important Investing Formula Investors Should See For Singapore Airlines Ltd

Over its past five fiscal years, Singapore’s flagship carrier, Singapore Airlines Ltd (SGX: C6L) has generated a return on equity (ROE) in the low single digits, as you can observe in the chart below:

Singapore Airlines' ROE chart - Wilson
Source: Singapore Airlines’ Annual Report

The company’s ROE has historically hovered only around 3% – that’s among the lowest ROEs for the 30 stocks that make up the Straits Times Index (SGX: ^STI). But, the metric did climb to 6%  in the fiscal year ended 31 March 2016 (FY2016).

The return on equity (ROE) metric measures a company’s ability to generate a profit with the shareholders’ capital it has. Generally speaking, a high ROE is preferred over a low one, all things being equal.

But, it is also important to breakdown the ROE into greater detail to see just why a company’s performance is the way it is. The breakdown is given in the formula below:

ROE = Profit Margin x Asset Turnover x Equity Multiplier

Some of you may recognise this formula as the DuPont Analysis. The DuPont Corporation created it nearly a century ago in the 1920s to measure its own internal efficiency.

Let’s see what the DuPont analysis can tell us about Singapore Airlines’ ROE:

Singapore Airlines' DuPont analysis chart - Wilson
Source: Singapore Airlines’ Annual Report

For the timeframe under study, the airline’s profit margin mirrored the trend in its ROE, stagnating between 2.6% and 2.9% until FY2016 when it more than doubled to 5.6%. Much of this improvement in the profit margin is attributable to lower oil prices. Fuel costs accounted for a whopping 37% of total operating expenses in FY2015, hence the fall in oil prices benefitted Singapore Airlines’ bottom-line in FY2016.

The second component of the DuPont analysis, the asset turnover, is a measure of how good Singapore Airlines is at utilizing its assets to generate revenue. It is calculated by dividing the company’s revenue with its assets. Generally, a higher asset turnover translates to a better performance.

Because Singapore Airlines is in an asset intensive business, the asset turnover is a useful metric to measure how well the company utilizes its fleet of aircrafts and spare parts. From the chart above, Singapore Airlines has generated a pretty consistent asset turnover over its last five fiscal years, although the number has showed a slight sign of decline, from 0.67 in FY2012 to 0.64 in FY2016.

The last component of the DuPont formula is the equity multiplier and it is found by dividing a company’s assets with its equity. It is a gauge for how much leverage – and thus financial risk – Singapore Airlines is taking on.

The airline’s equity multiplier has been creeping up slightly, from 1.67 in FY2012 to 1.8 in FY2016. This contributed to the spike in Singapore Airlines’ ROE that was seen in FY2016.

A Fool’s take

To sum up what the DuPont formula has showed us, Singapore Airlines had been a beneficiary of lower fuel costs in FY2016. Higher leverage also played a part in the higher ROE, but the main contributor was the spike in the profit margin.

It should be noted that more work needs to be done beyond the DuPont analysis before any firm investing conclusion can be made on Singapore Airlines. This look at the company’s ROE should only be seen as a useful starting point for further research.

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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 Wilson Ong doesn’t own shares in any companies mentioned.