Austal (ASX:ASB) Might Be Having Difficulty Using Its Capital Effectively

There are a few key trends to look for if we want to identify the next multi-bagger. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Austal (ASX:ASB), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Austal:

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

0.026 = AU$35m ÷ (AU$1.7b - AU$345m) (Based on the trailing twelve months to December 2022).

Therefore, Austal has an ROCE of 2.6%. In absolute terms, that's a low return and it also under-performs the Aerospace & Defense industry average of 9.0%.

Check out our latest analysis for Austal

Above you can see how the current ROCE for Austal compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Austal.

So How Is Austal's ROCE Trending?

On the surface, the trend of ROCE at Austal doesn't inspire confidence. To be more specific, ROCE has fallen from 6.6% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Austal has decreased its current liabilities to 20% 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 Bottom Line On Austal's ROCE

Bringing it all together, while we're somewhat encouraged by Austal's reinvestment in its own business, we're aware that returns are shrinking. Although the market must be expecting these trends to improve because the stock has gained 60% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

If you want to know some of the risks facing Austal we've found 3 warning signs (2 are a bit unpleasant!) that you should be aware of before investing here.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.