Capital Allocation Trends At Krones (ETR:KRN) Aren't Ideal

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Krones (ETR:KRN), we don't think it's current trends fit the mold of a multi-bagger.

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

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

0.035 = €60m ÷ (€3.3b - €1.5b) (Based on the trailing twelve months to June 2021).

Thus, Krones has an ROCE of 3.5%. Ultimately, that's a low return and it under-performs the Machinery industry average of 8.3%.

See our latest analysis for Krones

In the above chart we have measured Krones' 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 Krones.

The Trend Of ROCE

On the surface, the trend of ROCE at Krones doesn't inspire confidence. Around five years ago the returns on capital were 17%, but since then they've fallen to 3.5%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

Another thing to note, Krones has a high ratio of current liabilities to total assets of 47%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

From the above analysis, we find it rather worrisome that returns on capital and sales for Krones have fallen, meanwhile the business is employing more capital than it was five years ago. In spite of that, the stock has delivered a 6.1% return to shareholders who held over the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

If you're still interested in Krones it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.

While Krones 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.

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.

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