Lechwerke (FRA:LEC) Is Finding It Tricky To Allocate Its Capital

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? 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. So after glancing at the trends within Lechwerke (FRA:LEC), we weren't too hopeful.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Lechwerke:

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

0.035 = €23m ÷ (€1.8b - €1.1b) (Based on the trailing twelve months to December 2021).

Thus, Lechwerke has an ROCE of 3.5%. Ultimately, that's a low return and it under-performs the Electric Utilities industry average of 7.7%.

See 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 want to delve into the historical earnings, revenue and cash flow of Lechwerke, check out these free graphs here.

So How Is Lechwerke's ROCE Trending?

There is reason to be cautious about Lechwerke, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 16% 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 Lechwerke becoming one if things continue as they have.

On a separate but related note, it's important to know that Lechwerke has a current liabilities to total assets ratio of 63%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From Lechwerke's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Yet despite these poor fundamentals, the stock has gained a huge 113% over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Like most companies, Lechwerke does come with some risks, and we've found 1 warning sign that you should be aware of.

While Lechwerke 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.

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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.