Capital Allocation Trends At Wärtsilä Oyj Abp (HEL:WRT1V) Aren't Ideal

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. Basically the company is earning less on its investments and it is also reducing its total assets. So after glancing at the trends within Wärtsilä Oyj Abp (HEL:WRT1V), we weren't too hopeful.

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 Wärtsilä Oyj Abp, this is the formula:

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

0.082 = €268m ÷ (€6.7b - €3.5b) (Based on the trailing twelve months to September 2023).

Thus, Wärtsilä Oyj Abp has an ROCE of 8.2%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 11%.

Check out our latest analysis for Wärtsilä Oyj Abp

In the above chart we have measured Wärtsilä Oyj Abp's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Wärtsilä Oyj Abp here for free.

What Can We Tell From Wärtsilä Oyj Abp's ROCE Trend?

In terms of Wärtsilä Oyj Abp's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 15%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Wärtsilä Oyj Abp to turn into a multi-bagger.

On a side note, Wärtsilä Oyj Abp's current liabilities have increased over the last five years to 51% 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.

In Conclusion...

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Despite the concerning underlying trends, the stock has actually gained 9.0% over the last five years, so it might be that the investors are expecting the trends to reverse. 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 Wärtsilä Oyj Abp it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.

While Wärtsilä Oyj Abp 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.