RCL Foods' (JSE:RCL) Returns On Capital Not Reflecting Well On The Business

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. So after glancing at the trends within RCL Foods (JSE:RCL), we weren't too hopeful.

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. To calculate this metric for RCL Foods, this is the formula:

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

0.014 = R220m ÷ (R24b - R8.8b) (Based on the trailing twelve months to December 2020).

Thus, RCL Foods has an ROCE of 1.4%. In absolute terms, that's a low return and it also under-performs the Food industry average of 13%.

See our latest analysis for RCL Foods

In the above chart we have measured RCL Foods' 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 RCL Foods.

What Can We Tell From RCL Foods' ROCE Trend?

There is reason to be cautious about RCL Foods, given the returns are trending downwards. To be more specific, the ROCE was 8.5% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect RCL Foods to turn into a multi-bagger.

On a side note, RCL Foods' current liabilities have increased over the last five years to 36% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 1.4%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

The Bottom Line

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors haven't taken kindly to these developments, since the stock has declined 25% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One more thing to note, we've identified 1 warning sign with RCL Foods and understanding it should be part of your investment process.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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