Return on invested capital (or ROIC) shows how effectively a company employs its capital. A higher ratio denotes more dollars of profits are generated by each dollar of capital employed.
ROIC should be higher than the company’s weighted average cost of capital (or WACC). Otherwise, it indicates that the company is not employing its capital effectively. ROIC is calculated by dividing earnings before interest taxes (or EBIT) by the total capital employed.
Lower WACC and higher ROIC
Since the theme park industry is capital-intensive in nature, companies like Six Flags Entertainment (SIX), Cedar Fair (FUN), and SeaWorld Entertainment (SEAS) make extensive use of leverage to fund their capital expenditures. We all know that cost of debt is cheaper than equity since interest on debt is tax deductible. On the other hand, equity holders require higher return for taking higher risk on their investments.
The above chart shows that Six Flags Entertainment’s ROIC has been higher than WACC for most of the last three years. This is a positive sign for the company. As of January 15, 2015, Six Flags Entertainment’s ROIC and WACC stood at 9.2% and 5.9%, respectively. This shows that Six Flags is employing its debt capital effectively.
In order to avoid the risk of investing in a single theme park company, investors may invest in ETFs such as the Consumer Discretionary Select Sector SPDR Fund (XLY) and the iShares U.S. Consumer Services ETF (IYC).