Returns On Capital At Thermax (NSE:THERMAX) Paint A Concerning Picture

When researching a stock for investment, what can tell us that the company is in decline? 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 glancing at the trends within Thermax (NSE:THERMAX), we weren't too hopeful.

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. Analysts use this formula to calculate it for Thermax:

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

0.05 = ₹1.6b ÷ (₹60b - ₹28b) (Based on the trailing twelve months to December 2020).

Therefore, Thermax has an ROCE of 5.0%. 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 Thermax

Above you can see how the current ROCE for Thermax 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.

What Does the ROCE Trend For Thermax Tell Us?

In terms of Thermax's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 15% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Thermax becoming one if things continue as they have.

On a separate but related note, it's important to know that Thermax has a current liabilities to total assets ratio of 47%, 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Key Takeaway

In summary, it's unfortunate that Thermax is generating lower returns from the same amount of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 91% return 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.

If you'd like to know about the risks facing Thermax, we've discovered 3 warning signs that you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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