Enel Generación Chile (SNSE:ENELGXCH) Will Be Hoping To Turn Its Returns On Capital Around

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 combination can tell you that not only is the company investing less, it's earning less on what it does invest. In light of that, from a first glance at Enel Generación Chile (SNSE:ENELGXCH), we've spotted some signs that it could be struggling, so let's investigate.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Enel Generación Chile, this is the formula:

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

0.075 = CL$218b ÷ (CL$4.2t - CL$1.3t) (Based on the trailing twelve months to September 2022).

Therefore, Enel Generación Chile has an ROCE of 7.5%. In absolute terms, that's a low return, but it's much better than the Renewable Energy industry average of 5.6%.

Our analysis indicates that ENELGXCH is potentially overvalued!

Above you can see how the current ROCE for Enel Generación Chile 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 Enel Generación Chile here for free.

What The Trend Of ROCE Can Tell Us

There is reason to be cautious about Enel Generación Chile, given the returns are trending downwards. To be more specific, the ROCE was 14% five years ago, but since then it has dropped noticeably. 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 Enel Generación Chile becoming one if things continue as they have.

On a side note, Enel Generación Chile's current liabilities have increased over the last five years to 31% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

The Bottom Line On Enel Generación Chile's ROCE

In summary, it's unfortunate that Enel Generación Chile is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 56% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Enel Generación Chile (of which 1 is potentially serious!) that you should know about.

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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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.