Be Wary Of Shoprite Holdings (JSE:SHP) And Its Returns On Capital

By
Simply Wall St
Published
May 08, 2022
JSE:SHP
Source: Shutterstock

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Shoprite Holdings (JSE:SHP) 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?

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. The formula for this calculation on Shoprite Holdings is:

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

0.19 = R10b ÷ (R86b - R32b) (Based on the trailing twelve months to January 2022).

Therefore, Shoprite Holdings has an ROCE of 19%. That's a relatively normal return on capital, and it's around the 17% generated by the Consumer Retailing industry.

Check out our latest analysis for Shoprite Holdings

roce
JSE:SHP Return on Capital Employed May 8th 2022

In the above chart we have measured Shoprite Holdings' 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 Shoprite Holdings.

The Trend Of ROCE

On the surface, the trend of ROCE at Shoprite Holdings doesn't inspire confidence. Over the last five years, returns on capital have decreased to 19% from 33% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Shoprite Holdings has decreased its current liabilities to 38% 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.

The Bottom Line On Shoprite Holdings' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Shoprite Holdings is reinvesting for growth and has higher sales as a result. In light of this, the stock has only gained 23% over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

If you'd like to know more about Shoprite Holdings, we've spotted 2 warning signs, and 1 of them is concerning.

While Shoprite Holdings 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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