Gyeongnam Steel (KOSDAQ:039240) May Have Issues Allocating Its Capital

What financial metrics can indicate to us that a company is maturing or even 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. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. In light of that, from a first glance at Gyeongnam Steel (KOSDAQ:039240), we've spotted some signs that it could be struggling, so let's investigate.

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. The formula for this calculation on Gyeongnam Steel is:

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

0.058 = ₩5.3b ÷ (₩139b - ₩47b) (Based on the trailing twelve months to December 2020).

Thus, Gyeongnam Steel has an ROCE of 5.8%. In absolute terms, that's a low return, but it's much better than the Metals and Mining industry average of 4.7%.

See our latest analysis for Gyeongnam Steel

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

The Trend Of ROCE

In terms of Gyeongnam Steel's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 14% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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. If these trends continue, we wouldn't expect Gyeongnam Steel to turn into a multi-bagger.

On a side note, Gyeongnam Steel has done well to pay down its current liabilities to 34% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Key Takeaway

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Yet despite these concerning fundamentals, the stock has performed strongly with a 90% 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.

On a final note, we found 5 warning signs for Gyeongnam Steel (1 is significant) you should be aware of.

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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