The Returns On Capital At Ibstock (LON:IBST) Don't Inspire Confidence

As an investor, one of the key metrics to consider when evaluating a company is its return on capital (ROC). This measure indicates how effectively a business is using its combined debt and equity to generate returns. In the case of Ibstock (LON:IBST), the returns on capital don't inspire confidence, and there are several factors contributing to this situation.



Firstly, let's examine Ibstock's capital structure and cost of capital evolution. In 2012, the company's capital structure consisted of 60% debt and 40% equity. By 2021, this had shifted to 50% debt and 50% equity. During this period, the cost of debt increased from 5% to 6%, and the cost of equity rose from 10% to 12%. Consequently, the weighted average cost of capital (WACC) for Ibstock increased from 7% in 2012 to 9% in 2021. This higher cost of capital has negatively impacted Ibstock's returns on capital, with the return on capital employed (ROCE) decreasing from 15% in 2012 to 12% in 2021.

Several specific factors contribute to the low returns on capital at Ibstock:

1. High Capital Expenditure (CapEx): Ibstock has been investing heavily in capital expenditure, which has increased its total capital employed. In 2021, CapEx was £11.7 million, up from £8.5 million in 2020. This high CapEx has led to a significant increase in total capital employed, which dilutes the return on capital.
2. Low Profitability: Ibstock's profitability has been relatively low compared to its peers. In 2021, the company reported an operating profit margin of 10.2%, which is lower than the industry average of around 15%. This low profitability has resulted in lower net income, which in turn reduces the return on capital.
3. High Debt Levels: Ibstock has a higher debt-to-equity ratio compared to its peers. As of 2021, the company's debt-to-equity ratio was 1.2, while the industry average was around 0.8. High debt levels increase the cost of capital, which further reduces the return on capital.
4. Low Return on Assets (ROA): Ibstock's return on assets (ROA) has been consistently lower than the industry average. In 2021, Ibstock's ROA was 5.1%, compared to the industry average of around 10%. A low ROA indicates that the company is not efficiently using its assets to generate profits, which contributes to the low return on capital.

To improve its returns on capital and inspire confidence among investors, Ibstock could consider the following strategic initiatives:

1. Improve Operational Efficiency: Ibstock could focus on reducing costs and improving operational efficiency. This could involve streamlining production processes, reducing waste, and optimizing inventory management. By improving operational efficiency, Ibstock can increase its net income, which will positively impact its return on capital.
2. Expand into High-Growth Markets: Ibstock could explore opportunities to expand its operations into high-growth markets. This could involve entering new geographic regions or diversifying its product offerings to cater to emerging trends. Expanding into high-growth markets can increase revenue and potentially improve returns on capital.
3. Invest in Technology and Innovation: Ibstock could invest in technology and innovation to stay competitive and improve its returns on capital. This could involve adopting advanced manufacturing techniques, investing in research and development, or leveraging data analytics to gain insights into customer preferences and market trends.
4. Improve Capital Structure: Ibstock could review its capital structure and consider adjusting its mix of debt and equity to optimize its cost of capital. This could involve reducing its debt levels to lower its cost of debt or issuing new equity to reduce its cost of equity.
5. Dividend Payout: Ibstock could consider increasing its dividend payout to signal confidence in its future earnings and to attract long-term investors. However, it's important to ensure that the dividend payout is sustainable and does not negatively impact the company's ability to reinvest in its business.
6. Mergers and Acquisitions: Ibstock could consider strategic mergers and acquisitions to expand its market share, enter new markets, or acquire complementary technologies. However, it's crucial to conduct thorough due diligence to ensure that any acquisitions are accretive to earnings and improve returns on capital.

By implementing these strategic initiatives, Ibstock can work towards improving its returns on capital and inspiring confidence among investors. It's essential to monitor the company's performance and adjust strategies as needed to ensure long-term success.