Subsea 7 (OB:SUBC) Could Be Struggling To Allocate Capital

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. 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)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Subsea 7 is:

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).

Therefore, Subsea 7 has an ROCE of 1.8%. Ultimately, that's a low return and it under-performs the Energy Services industry average of 11%.

View our latest analysis for Subsea 7

In the above chart we have measured Subsea 7's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Subsea 7 here for free.

What Does the ROCE Trend For Subsea 7 Tell Us?

We are a bit worried about the trend of returns on capital at Subsea 7. Unfortunately the returns on capital have diminished from the 4.8% 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. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Subsea 7 to turn into a multi-bagger.

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.

Our Take On Subsea 7's ROCE

In summary, it's unfortunate that Subsea 7 is generating lower returns from the same amount of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 55% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Subsea 7 does have some risks though, and we've spotted 3 warning signs for Subsea 7 that you might be interested in.

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.