Returns On Capital Signal Difficult Times Ahead For Meridian Energy (NZSE:MEL)

When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. 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. On that note, looking into Meridian Energy (NZSE:MEL), we weren't too upbeat about how things were going.

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 Meridian Energy is:

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

0.017 = NZ$154m ÷ (NZ$10b - NZ$720m) (Based on the trailing twelve months to June 2023).

Therefore, Meridian Energy has an ROCE of 1.7%. Ultimately, that's a low return and it under-performs the Renewable Energy industry average of 6.7%.

View our latest analysis for Meridian Energy

In the above chart we have measured Meridian Energy's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Meridian Energy.

So How Is Meridian Energy's ROCE Trending?

In terms of Meridian Energy's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 4.8%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Meridian Energy becoming one if things continue as they have.

What We Can Learn From Meridian Energy's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Yet despite these concerning fundamentals, the stock has performed strongly with a 95% 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.

If you want to know some of the risks facing Meridian Energy we've found 2 warning signs (1 doesn't sit too well with us!) that you should be aware of before investing here.

While Meridian Energy 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.