To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. In light of that, from a first glance at Enerflex (TSE:EFX), we've spotted some signs that it could be struggling, so let's investigate.
What is Return On Capital Employed (ROCE)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Enerflex, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.061 = CA$116m ÷ (CA$2.2b - CA$288m) (Based on the trailing twelve months to December 2020).
So, Enerflex has an ROCE of 6.1%. In absolute terms, that's a low return and it also under-performs the Energy Services industry average of 9.6%.
roce
Above you can see how the current ROCE for Enerflex compares to its prior returns on capital, but there's only so much you can tell from the past.
How Are Returns Trending?
We are a bit worried about the trend of returns on capital at Enerflex. To be more specific, the ROCE was 8.0% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Enerflex becoming one if things continue as they have.
In Conclusion...
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 27% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.