If we want to avoid a business that is in decline, what trends can warn us in advance? A business that is potentially in decline often shows two trends, one return on the capital employed (ROCE), which is declining, and a base of the capital employed, which also decreases. Ultimately, this means that the company earns less per dollar invested and, in addition, its capital employed base shrinks. Against this background, at first glance Renewable energy from Tidewater (TSE:LCFS) we have spotted some signs that suggest the company is in trouble, so let’s investigate.
Return on Capital Employed (ROCE): What is it?
For those who don’t know what ROCE is, it measures the amount of pre-tax profit a company can generate with the capital employed in its business. To calculate this metric for Tidewater Renewables, the formula is:
Return on capital = earnings before interest and taxes (EBIT) ÷ (total assets – current liabilities)
0.0096 = CA$7.7 million ÷ (CA$1.1 billion – CA$270 million) (Based on the last twelve months to June 2024).
So, Tidewater Renewables has a ROCE of 1.0%. In absolute terms, this is a low return and it is also below the industry average of 8.5% in the oil and gas sector.
Check out our latest analysis for Tidewater Renewables
Above you can see how the current ROCE for Tidewater Renewables compares to its past returns on capital, but there is only so much to be inferred from the past. If you want, you can see the forecasts of the analysts who cover Tidewater Renewables for free.
The trend of ROCE
We are somewhat concerned about the trend in returns on capital at Tidewater Renewables. Unfortunately, returns on capital have fallen from the 2.5% they were generating two years ago. And in terms of capital employed, the company is using about the same amount of capital as it was then. Companies that exhibit these characteristics don’t tend to shrink, but they may be mature and have pressure on their margins from competition. If these trends continue, we don’t expect Tidewater Renewables to become a multibagger.
As an aside, Tidewater Renewables’ current liabilities have risen to 25% of total assets over the past two years, which distorts the ROCE to some extent. Without this increase, the ROCE would probably be even lower than 1.0%. While the ratio is not too high at the moment, it is worth keeping an eye on because if it gets particularly high, the company could face new elements of risk.
What we can learn from Tidewater Renewables’ ROCE
Ultimately, a trend of lower returns on the same capital employed is not usually an indication that we are dealing with a growth stock. Unsurprisingly, the stock has fallen 81% over the past three years, so investors are recognizing these changes and are not liking the company’s prospects. Unless these metrics move in a more positive direction, we would look elsewhere.
However, Tidewater Renewables brings with it some risks, 2 warning signals in our investment analysis, and we are not so happy with one of them …
If you want to look for solid companies with high returns, check out this free List of companies with good balance sheets and impressive return on equity.
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