Is Coda Octopus Group's Return on Capital a Cause for Concern?

Coda Octopus Group (NASDAQ:CODA), a leader in advanced marine and subsea technologies, has captured investor attention through its innovations in autonomous systems and defense-related applications. However, beneath the surface of its strategic moves and product milestones lies a critical question: are the company’s returns on capital justifying its valuation? This analysis dives into CODA’s financial metrics—return on equity (ROE), return on assets (ROA), and return on invested capital (ROIC)—to assess whether its capital allocation strategies are delivering sufficient value for shareholders.

Financial Performance Overview: Growth Amid Challenges

CODA’s fiscal 2024 results showed modest improvements, with revenue reaching $20.3 million (+5% year-over-year) and net income climbing to $3.6 million (+17%). Yet, these gains come against a backdrop of operational headwinds:
- Revenue Volatility: Annual revenue has declined since 2022, dropping from $24.1 million to $20.3 million in 2024.
- Margins Under Pressure: Gross margins improved to 69.8% in 2024 but face risks from shifts in customer mix (e.g., reliance on defense contracts).
- Cash Reserves: The company ended 2024 with $22.48 million in cash, down from $24.45 million in 2023 due to its acquisition of Precision Acoustics Limited.

Recent Q1 2025 results (ended January 31, 2025) added mixed signals:
- Revenue rose 16.8% YoY to $5.2 million, driven by the Precision Acoustics acquisition and defense services.
- Net income jumped 44.9% to $913,000, but operating expenses increased 11.8% to $2.8 million, reflecting integration costs.

Deep Dive into Returns on Capital: The Red Flags

Let’s scrutinize CODA’s returns on equity, assets, and invested capital using the latest available data:

1. Return on Equity (ROE): A Modest 6.86%

• Calculation: ROE = Net Income / Shareholders’ Equity
• 2024 ROE: 6.86%, up slightly from 6.45% in 2023.
• Benchmark Comparison: A ROE below 10% is generally unimpressive for a tech or capital-intensive firm. CODA’s ROE suggests that equity holders are not being rewarded proportionally for the risks taken.

2. Return on Assets (ROA): 6.33%

• Calculation: ROA = Net Income / Total Assets
• 2024 ROA: 6.33%, up from 6.03% in 2023.
• Critique: With total assets of $57.5 million, CODA generates just $0.063 of profit per dollar of assets—a mediocre return for a company in the high-growth subsea tech sector.

3. Return on Invested Capital (ROIC): A Troubling 4.92%

• Calculation: ROIC = NOPAT / Invested Capital
• 2024 ROIC: Estimated 4.92%, down from 6.33% in 2023 (when ROIC was conflated with ROA due to minimal debt).
• Key Issue: ROIC measures how effectively a company uses its capital (debt + equity) to generate profits. A sub-5% ROIC indicates that CODA’s capital investments (e.g., R&D, acquisitions) are not yielding sufficient returns. For comparison, industry peers like Teledyne Technologies (TDY) typically achieve ROICs above 10%.

A visual analysis of CODA’s ROIC would reveal its persistent underperformance relative to peers, with capital efficiency declining in 2024.

The Risks to CODA’s Capital Allocation Strategy

Even if CODA’s products (like the DAVD Untethered System) hold promise, several risks cloud its path to improving returns:

1. Overreliance on a Few Clients

• Concentration Risk: In Q3 2024, 68% of revenue came from its top three customers, primarily in defense and energy sectors.
• Policy Uncertainties: U.S. defense budget cuts and delays in offshore energy permits threaten revenue stability.

2. Intense Competition

• Rivals like Kongsberg Gruppen and Teledyne Technologies dominate the market with established brands and deeper pockets. CODA’s niche innovations (e.g., Echoscope® sonar) face uphill battles for market share.

3. High Costs of Innovation

• R&D spending rose 11.8% YoY in Q1 2025 to $540,000, yet the payoff remains uncertain. For instance, the DAVD system’s first order of $800,000 (for 16 units) pales compared to CODA’s total annual revenue.

Conclusion: Caution Advised Until ROIC Improves

Coda Octopus Group’s financials paint a picture of a company stuck in low-return purgatory. With ROIC at 4.92%—well below its cost of capital—and a revenue base still vulnerable to macroeconomic shifts, investors must weigh its long-term potential against its current underperformance.

Key Data Points to Consider:
- ROIC vs. Peers: 4.92% vs. industry average of 8–12%.
- Revenue Dependence: 68% of sales from top three clients.
- Cash Burn: Despite $22 million in cash, acquisitions (e.g., Precision Acoustics) and R&D are eating into reserves.

While CODA’s DAVD system and defense partnerships offer growth avenues, returns on capital must improve significantly to justify its valuation. Until then, the risks of prolonged underperformance—especially in a sector with high capital demands—outweigh the rewards for most investors.

A comparison would likely show CODA’s stock price rising despite stagnant ROIC, signaling a disconnect between market optimism and underlying profitability.

Investors seeking exposure to subsea tech should look elsewhere until CODA demonstrates it can convert capital into sustainable, high-margin growth.