Cielo (BVMF:CIEL3) Is Finding It Tricky To Allocate Its Capital

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. Having said that, after a brief look, Cielo (BVMF:CIEL3) we aren't filled with optimism, but let's investigate further.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Cielo is:

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

0.096 = R$2.5b ÷ (R$103b - R$77b) (Based on the trailing twelve months to September 2022).

Thus, Cielo has an ROCE of 9.6%. Ultimately, that's a low return and it under-performs the IT industry average of 16%.

See our latest analysis for Cielo

In the above chart we have measured Cielo's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Cielo.

How Are Returns Trending?

We are a bit worried about the trend of returns on capital at Cielo. Unfortunately the returns on capital have diminished from the 18% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Cielo becoming one if things continue as they have.

On a side note, Cielo's current liabilities are still rather high at 75% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

Our Take On Cielo's ROCE

In summary, it's unfortunate that Cielo is generating lower returns from the same amount of capital. We expect this has contributed to the stock plummeting 72% during the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Cielo does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those doesn't sit too well with us...

While Cielo may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.