Pick n Pay Stores' (JSE:PIK) Returns On Capital Not Reflecting Well On The Business

There are a few key trends to look for if we want to identify the next multi-bagger. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. 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.

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 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).

Therefore, Pick n Pay Stores has an ROCE of 17%. That's a pretty standard return and it's in line with the industry average of 17%.

See our latest analysis for Pick n Pay Stores

In the above chart we have measured Pick n Pay Stores' 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 Pick n Pay Stores.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Pick n Pay Stores, we didn't gain much confidence. 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. 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

In Conclusion...

In summary, Pick n Pay Stores is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And in the last five years, the stock has given away 11% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with Pick n Pay Stores (including 1 which shouldn't be ignored) .

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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