If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. On that note, looking into Midway Holding (STO:MIDW B), we weren't too upbeat about how things were going.
What is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Midway Holding:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.022 = kr12m ÷ (kr717m - kr155m) (Based on the trailing twelve months to September 2020).
Thus, Midway Holding has an ROCE of 2.2%. Ultimately, that's a low return and it under-performs the Industrials industry average of 11%.
Check out our latest analysis for Midway Holding
Above you can see how the current ROCE for Midway Holding compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
The trend of returns that Midway Holding is generating are raising some concerns. Unfortunately, returns have declined substantially over the last five years to the 2.2% we see today. What's equally concerning is that the amount of capital deployed in the business has shrunk by 25% over that same period. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.
On a related note, Midway Holding has decreased its current liabilities to 22% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
In Conclusion...
In summary, it's unfortunate that Midway Holding is shrinking its capital base and also generating lower returns. And long term shareholders have watched their investments stay flat over the last five years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
One more thing to note, we've identified 4 warning signs with Midway Holding and understanding them should be part of your investment process.
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About OM:HAKI B
HAKI Safety
Offers scaffolding systems and services for complex projects in industry, infrastructure, and construction.
Good value with reasonable growth potential.