Here's What To Make Of Pick n Pay Stores' (JSE:PIK) Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Pick n Pay Stores (JSE:PIK) 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 Pick n Pay Stores:

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

0.17 = R2.9b ÷ (R38b - R21b) (Based on the trailing twelve months to August 2020).

Thus, Pick n Pay Stores has an ROCE of 17%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Consumer Retailing industry average of 15%.

View our latest analysis for Pick n Pay Stores

Above you can see how the current ROCE for Pick n Pay Stores 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 Pick n Pay Stores here for free.

How Are Returns Trending?

In terms of Pick n Pay Stores' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 30%, but since then they've fallen to 17%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Pick n Pay Stores has done well to pay down its current liabilities to 54% of total assets. So we could link some of this to the decrease in ROCE. 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

Our Take On Pick n Pay Stores' ROCE

Bringing it all together, while we're somewhat encouraged by Pick n Pay Stores' reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 11% over the last five years, investors may not be too optimistic on this trend improving either. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

Pick n Pay Stores does have some risks, we noticed 3 warning signs (and 1 which is significant) we think you should know about.

While Pick n Pay Stores 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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