Inchcape (LON:INCH) 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? 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. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. In light of that, from a first glance at Inchcape (LON:INCH), we've spotted some signs that it could be struggling, so let's investigate.

Understanding 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. The formula for this calculation on Inchcape is:

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

0.13 = UK£227m ÷ (UK£3.6b - UK£1.7b) (Based on the trailing twelve months to December 2021).

Thus, Inchcape has an ROCE of 13%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Retail Distributors industry average of 14%.

Check out our latest analysis for Inchcape

Above you can see how the current ROCE for Inchcape compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

We are a bit worried about the trend of returns on capital at Inchcape. About five years ago, returns on capital were 20%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 Inchcape to turn into a multi-bagger.

Another thing to note, Inchcape has a high ratio of current liabilities to total assets of 49%. 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 Inchcape is generating lower returns from the same amount of capital. And long term shareholders have watched their investments stay flat over the last five years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a separate note, we've found 2 warning signs for Inchcape you'll probably want to know about.

While Inchcape 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.