Regal (TSE:7938) Is Finding It Tricky To Allocate Its Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. And from a first read, things don't look too good at Regal (TSE:7938), so let's see why.

What Is 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. The formula for this calculation on Regal is:

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

0.018 = JP¥250m ÷ (JP¥27b - JP¥13b) (Based on the trailing twelve months to December 2023).

Therefore, Regal has an ROCE of 1.8%. Ultimately, that's a low return and it under-performs the Luxury industry average of 4.8%.

Check out our latest analysis for Regal

Historical performance is a great place to start when researching a stock so above you can see the gauge for Regal's ROCE against it's prior returns. If you're interested in investigating Regal's past further, check out this free graph covering Regal's past earnings, revenue and cash flow.

How Are Returns Trending?

The trend of ROCE at Regal is showing some signs of weakness. The company used to generate 5.8% on its capital five years ago but it has since fallen noticeably. On top of that, the business is utilizing 28% less capital within its operations. The fact that both are shrinking is an indication that the business is going through some tough times. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

On a side note, Regal's current liabilities have increased over the last five years to 47% 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.

The Bottom Line

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. It should come as no surprise then that the stock has fallen 12% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a final note, we found 4 warning signs for Regal (2 are a bit concerning) you should be aware of.

While Regal 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.