Wescoal Holdings (JSE:WSL) May Have Issues Allocating Its Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Wescoal Holdings (JSE:WSL) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What is it?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Wescoal Holdings:

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

0.015 = R45m ÷ (R4.1b - R1.0b) (Based on the trailing twelve months to September 2020).

Therefore, Wescoal Holdings has an ROCE of 1.5%. In absolute terms, that's a low return and it also under-performs the Trade Distributors industry average of 13%.

Check out our latest analysis for Wescoal Holdings

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Wescoal Holdings, check out these free graphs here.

The Trend Of ROCE

On the surface, the trend of ROCE at Wescoal Holdings doesn't inspire confidence. Over the last five years, returns on capital have decreased to 1.5% from 3.4% five years ago. However it looks like Wescoal Holdings might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Wescoal Holdings has decreased its current liabilities to 25% of total assets. That could partly explain why the ROCE has dropped. 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. 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.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Wescoal Holdings' reinvestment in its own business, we're aware that returns are shrinking. And in the last five years, the stock has given away 45% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think Wescoal Holdings has the makings of a multi-bagger.

If you'd like to know more about Wescoal Holdings, we've spotted 4 warning signs, and 2 of them are concerning.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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