The Returns At Western Areas (ASX:WSA) Provide Us With Signs Of What's To Come

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Western Areas (ASX:WSA), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

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. Analysts use this formula to calculate it for Western Areas:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.089 = AU$51m ÷ (AU$642m - AU$65m) (Based on the trailing twelve months to December 2019).

So, Western Areas has an ROCE of 8.9%. In absolute terms, that's a low return but it's around the Metals and Mining industry average of 9.8%.

Check out our latest analysis for Western Areas

Above you can see how the current ROCE for Western Areas compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

On the surface, the trend of ROCE at Western Areas doesn't inspire confidence. Around five years ago the returns on capital were 18%, but since then they've fallen to 8.9%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Western Areas has decreased its current liabilities to 10% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Western Areas' ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Western Areas. However, despite the promising trends, the stock has fallen 8.9% over the last five years, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you're still interested in Western Areas it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.

While Western Areas isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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