Caffyns (LON:CFYN) Could Be At Risk Of Shrinking As A Company

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 the company is producing less profit from its investments and its total assets are decreasing. And from a first read, things don't look too good at Caffyns (LON:CFYN), so let's see why.

Return On Capital Employed (ROCE): What is it?

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. Analysts use this formula to calculate it for Caffyns:

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

0.058 = UK£3.1m ÷ (UK£94m - UK£41m) (Based on the trailing twelve months to March 2021).

Thus, Caffyns has an ROCE of 5.8%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 10%.

View our latest analysis for Caffyns

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 Caffyns has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Caffyns Tell Us?

There is reason to be cautious about Caffyns, given the returns are trending downwards. To be more specific, the ROCE was 8.4% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Caffyns to turn into a multi-bagger.

On a separate but related note, it's important to know that Caffyns has a current liabilities to total assets ratio of 44%, which we'd consider pretty high. 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.

In Conclusion...

In summary, it's unfortunate that Caffyns is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 14% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you'd like to know more about Caffyns, we've spotted 4 warning signs, and 2 of them are significant.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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