Companhia de Saneamento de Minas Gerais (BVMF:CSMG3) Has Some Difficulty Using Its Capital Effectively

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. In light of that, from a first glance at Companhia de Saneamento de Minas Gerais (BVMF:CSMG3), we've spotted some signs that it could be struggling, so let's investigate.

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 Companhia de Saneamento de Minas Gerais:

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

0.081 = R$871m ÷ (R$12b - R$1.8b) (Based on the trailing twelve months to June 2022).

Thus, Companhia de Saneamento de Minas Gerais has an ROCE of 8.1%. Even though it's in line with the industry average of 8.2%, it's still a low return by itself.

Our analysis indicates that CSMG3 is potentially undervalued!

Above you can see how the current ROCE for Companhia de Saneamento de Minas Gerais compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Companhia de Saneamento de Minas Gerais here for free.

What Can We Tell From Companhia de Saneamento de Minas Gerais' ROCE Trend?

There is reason to be cautious about Companhia de Saneamento de Minas Gerais, given the returns are trending downwards. To be more specific, the ROCE was 10% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Companhia de Saneamento de Minas Gerais becoming one if things continue as they have.

In Conclusion...

In summary, it's unfortunate that Companhia de Saneamento de Minas Gerais is generating lower returns from the same amount of capital. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 70% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

On a final note, we've found 4 warning signs for Companhia de Saneamento de Minas Gerais that we think you should be aware of.

While Companhia de Saneamento de Minas Gerais 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.