SK Innovation (KRX:096770) Could Be Struggling To Allocate Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at SK Innovation (KRX:096770) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

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 SK Innovation:

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

0.028 = ₩1.6t ÷ (₩86t - ₩30t) (Based on the trailing twelve months to June 2024).

Thus, SK Innovation has an ROCE of 2.8%. Ultimately, that's a low return and it under-performs the Oil and Gas industry average of 5.0%.

View our latest analysis for SK Innovation

Above you can see how the current ROCE for SK Innovation compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering SK Innovation for free.

What Can We Tell From SK Innovation's ROCE Trend?

The trend of ROCE doesn't look fantastic because it's fallen from 4.6% five years ago, while the business's capital employed increased by 93%. That being said, SK Innovation raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with SK Innovation's earnings and if they change as a result from the capital raise.

On a side note, SK Innovation's current liabilities have increased over the last five years to 34% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 2.8%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

Our Take On SK Innovation's ROCE

In summary, SK Innovation is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has declined 28% over the last five years, investors may not be too optimistic on this trend improving either. Therefore based on the analysis done in this article, we don't think SK Innovation has the makings of a multi-bagger.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for SK Innovation (of which 1 can't be ignored!) that you should know about.

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.

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.