How Well Is Magellan Aerospace (TSE:MAL) Allocating Its Capital?

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base 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 Magellan Aerospace (TSE:MAL), we've spotted some signs that it could be struggling, so let's investigate.

What is 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. To calculate this metric for Magellan Aerospace, this is the formula:

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

0.056 = CA$53m ÷ (CA$1.1b - CA$168m) (Based on the trailing twelve months to September 2020).

So, Magellan Aerospace has an ROCE of 5.6%. In absolute terms, that's a low return and it also under-performs the Aerospace & Defense industry average of 8.5%.

See our latest analysis for Magellan Aerospace

Above you can see how the current ROCE for Magellan Aerospace 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 Magellan Aerospace here for free.

What The Trend Of ROCE Can Tell Us

There is reason to be cautious about Magellan Aerospace, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 13% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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 Magellan Aerospace becoming one if things continue as they have.

The Key Takeaway

In summary, it's unfortunate that Magellan Aerospace is generating lower returns from the same amount of capital. Long term shareholders who've owned the stock over the last five years have experienced a 22% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a final note, we've found 2 warning signs for Magellan Aerospace that we think you should be aware of.

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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