Cielo's (BVMF:CIEL3) Returns On Capital Tell Us There Is Reason To Feel Uneasy

What financial metrics can indicate to us that a company is maturing or even in decline? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. On that note, looking into Cielo (BVMF:CIEL3), we weren't too upbeat about how things were going.

Return On Capital Employed (ROCE): What is it?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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)

0.062 = R$1.6b ÷ (R$100b - R$75b) (Based on the trailing twelve months to December 2021).

Thus, Cielo has an ROCE of 6.2%. Ultimately, that's a low return and it under-performs the IT industry average of 14%.

See our latest analysis for Cielo

Above you can see how the current ROCE for Cielo 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 Cielo.

What The Trend Of ROCE Can Tell Us

We are a bit worried about the trend of returns on capital at Cielo. To be more specific, the ROCE was 21% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Cielo to turn into a multi-bagger.

On a side note, Cielo's current liabilities have increased over the last five years to 74% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 6.2%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

In Conclusion...

In summary, it's unfortunate that Cielo is generating lower returns from the same amount of capital. Unsurprisingly then, the stock has dived 81% over the last five years, so investors are recognizing these changes and don't like the company's prospects. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you want to continue researching Cielo, you might be interested to know about the 1 warning sign that our analysis has discovered.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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