Lechwerke (FRA:LEC) Could Be Struggling To Allocate Capital

What financial metrics can indicate to us that a company is maturing or even in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount 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. And from a first read, things don't look too good at Lechwerke (FRA:LEC), so let's see why.

Understanding 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 Lechwerke, this is the formula:

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

0.012 = €7.4m ÷ (€1.7b - €1.1b) (Based on the trailing twelve months to June 2021).

Thus, Lechwerke has an ROCE of 1.2%. In absolute terms, that's a low return and it also under-performs the Electric Utilities industry average of 7.4%.

View our latest analysis for Lechwerke

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Lechwerke has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Lechwerke's ROCE Trending?

We are a bit anxious about the trends of ROCE at Lechwerke. Unfortunately, returns have declined substantially over the last five years to the 1.2% we see today. What's equally concerning is that the amount of capital deployed in the business has shrunk by 57% over that same period. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. If these underlying trends continue, we wouldn't be too optimistic going forward.

On a side note, Lechwerke's current liabilities have increased over the last five years to 63% 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. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

Our Take On Lechwerke's ROCE

In summary, it's unfortunate that Lechwerke is shrinking its capital base and also generating lower returns. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 116%. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

One more thing, we've spotted 1 warning sign facing Lechwerke that you might find interesting.

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.

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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