Lechwerke (FRA:LEC) Has Some Difficulty Using Its Capital Effectively

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. So after we looked into Lechwerke (FRA:LEC), the trends above didn't look too great.

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. The formula for this calculation on Lechwerke is:

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

0.021 = €14m ÷ (€1.7b - €1.0b) (Based on the trailing twelve months to June 2023).

Therefore, Lechwerke has an ROCE of 2.1%. In absolute terms, that's a low return and it also under-performs the Electric Utilities industry average of 9.1%.

Check out our latest analysis for Lechwerke

Historical performance is a great place to start when researching a stock so above you can see the gauge for Lechwerke's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Lechwerke, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

We are a bit anxious about the trends of ROCE at Lechwerke. Unfortunately, returns have declined substantially over the last five years to the 2.1% we see today. On top of that, the business is utilizing 59% less capital within its operations. 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.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 60%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 2.1%. 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.

The Bottom Line On Lechwerke's ROCE

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. And long term shareholders have watched their investments stay flat over the last five years. 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 2 warning signs for Lechwerke (of which 1 is a bit concerning!) that you should know about.

While Lechwerke isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.