Be Wary Of Subsea 7 (OB:SUBC) And Its Returns On Capital

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? 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. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. And from a first read, things don't look too good at Subsea 7 (OB:SUBC), 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. Analysts use this formula to calculate it for Subsea 7:

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

0.018 = US$93m ÷ (US$7.6b - US$2.3b) (Based on the trailing twelve months to June 2023).

So, Subsea 7 has an ROCE of 1.8%. In absolute terms, that's a low return and it also under-performs the Energy Services industry average of 11%.

Check out our latest analysis for Subsea 7

Above you can see how the current ROCE for Subsea 7 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 Subsea 7 here for free.

What The Trend Of ROCE Can Tell Us

There is reason to be cautious about Subsea 7, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 4.8% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Subsea 7 becoming one if things continue as they have.

On a side note, Subsea 7's current liabilities have increased over the last five years to 31% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 1.8%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

The Bottom Line On Subsea 7's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Despite the concerning underlying trends, the stock has actually gained 32% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

One more thing, we've spotted 3 warning signs facing Subsea 7 that you might find interesting.

While Subsea 7 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.

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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.