Southern Steel Berhad's (KLSE:SSTEEL) Returns On Capital Tell Us There Is Reason To Feel Uneasy
Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. In light of that, from a first glance at Southern Steel Berhad (KLSE:SSTEEL), we've spotted some signs that it could be struggling, so let's investigate.
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. The formula for this calculation on Southern Steel Berhad is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.022 = RM18m ÷ (RM1.8b - RM1.0b) (Based on the trailing twelve months to September 2022).
Therefore, Southern Steel Berhad has an ROCE of 2.2%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 11%.
Check out our latest analysis for Southern Steel Berhad
Historical performance is a great place to start when researching a stock so above you can see the gauge for Southern Steel Berhad's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Southern Steel Berhad, check out these free graphs here.
What Does the ROCE Trend For Southern Steel Berhad Tell Us?
We are a bit anxious about the trends of ROCE at Southern Steel Berhad. Unfortunately, returns have declined substantially over the last five years to the 2.2% we see today. What's equally concerning is that the amount of capital deployed in the business has shrunk by 32% over that same period. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.
Another thing to note, Southern Steel Berhad has a high ratio of current liabilities to total assets of 56%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
Our Take On Southern Steel Berhad's ROCE
To see Southern Steel Berhad reducing the capital employed in the business in tandem with diminishing returns, is concerning. It should come as no surprise then that the stock has fallen 68% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
Southern Steel Berhad does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is concerning...
While Southern Steel Berhad may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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