Capital Allocation Trends At Ternium (NYSE:TX) Aren't Ideal

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Ternium (NYSE:TX) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding 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 Ternium:

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

0.11 = US$1.8b ÷ (US$18b - US$2.2b) (Based on the trailing twelve months to June 2023).

Therefore, Ternium has an ROCE of 11%. By itself that's a normal return on capital and it's in line with the industry's average returns of 11%.

Check out our latest analysis for Ternium

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

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Ternium doesn't inspire confidence. Around five years ago the returns on capital were 19%, but since then they've fallen to 11%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Ternium has done well to pay down its current liabilities to 12% of total assets. That could partly explain why the ROCE has dropped. 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.

Our Take On Ternium's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Ternium have fallen, meanwhile the business is employing more capital than it was five years ago. However the stock has delivered a 67% return to shareholders over the last five years, so investors might be expecting the trends to turn around. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Ternium does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is potentially serious...

While Ternium 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.