Volcano Berhad's Struggling ROCE and Capital Allocation: Is There a Turnaround in Sight?

Volcano Berhad (KLSE:VOLCANO), a machinery manufacturer, has faced mounting challenges in recent years as its Return on Capital Employed (ROCE) has plummeted to levels far below industry benchmarks. This decline raises critical questions about the company's ability to generate profitable growth and whether investors should hold out hope for a turnaround. Let's dissect the data to assess the risks and opportunities ahead.

ROCE in Free Fall: A Warning Sign

Volcano Berhad's ROCE—a key metric for evaluating capital efficiency—has deteriorated sharply. As of March 2025, its ROCE stood at 4.2%, down from 7% in 2022 and a staggering 61% decline over five years. This compares unfavorably to the Machinery industry average of 8.0%, signaling systemic inefficiencies (see Figure 1).

The decline is alarming given the company's aggressive capital raises, which have doubled its capital employed over five years. Yet, earnings (EBIT) have stagnated, rising by just 10% over the same period. This misalignment suggests new capital isn't being deployed effectively to boost profitability.

Capital Allocation: A Missed Opportunity?

Volcano Berhad's strategy of expanding capital employed without corresponding returns has backfired. A 100% increase in capital deployed since 2020 has not translated into revenue or profit growth. Revenue grew at a meager 0.3% annualized rate over five years, while net income shrank by 11.5% annually, contrasting with the industry's 5.3% growth.

The company's recent Q3 2025 results offer a mixed picture: Revenue rose 24% year-on-year to MYR21.2 million, but net profit increased only 15% to MYR1.15 million due to rising expenses. Gross margins have eroded, dropping to 5.4%, while debt has climbed to 31.5% of equity, up from zero five years ago. A negative interest coverage ratio (-8.4) further underscores cash flow struggles.

Stock Performance: Betting on Hope, Not Results

Despite dismal fundamentals, Volcano Berhad's stock price has risen 78% over three years, fueled by investor optimism about a turnaround. However, this optimism appears misplaced. Key risks include:
- Earnings quality warnings: Highlighted in early 2025, signaling potential accounting or operational issues.
- Leadership changes: The resignation of Executive Director Khoo Boo Wui in March 2024 introduced uncertainty.
- Dividend dilution: Final dividends for 2024 were just MYR0.005, down from previous years.

Analysts note the stock is 21-23% undervalued, but this assumes a recovery in ROCE and earnings. Without concrete steps to address inefficiencies, the valuation may remain speculative.

Historical data supports this dynamic: backtests reveal that Volcano's stock tends to rise immediately after earnings releases—peaking at a 2.5% gain within three days—but this optimism often fades. The short-term 100% win rate over three days contrasts with a 0% win rate over ten days, suggesting a pattern of initial investor enthusiasm followed by disappointment as fundamentals take hold. Over 30 days, performance rebounds to a 100% win rate, implying that longer-term investors might capture partial gains amid volatile sentiment. These results underscore the disconnect between fleeting market reactions and the company's weakening fundamentals.

Can Volcano Berhad Turn It Around?

The path to recovery hinges on two critical factors:
1. ROCE Improvement: The company must boost returns on its expanded capital base. Recent Q3 revenue growth hints at potential, but margins must stabilize.
2. Strategic Reinvestment: Redirecting capital toward high-return projects or cost-cutting could reverse the trend. However, with limited analyst coverage and opaque capital allocation details, investors lack clarity on execution plans.

Investment Thesis: Proceed With Caution

Volcano Berhad's struggles are deep-rooted, and its current trajectory offers little comfort. Key risks include:
- Stagnant EBIT: Capital employed growth outpaces earnings.
- Debt Accumulation: Rising leverage increases financial vulnerability.
- Earnings Volatility: Net income fell 24% in the first nine months of 2025 despite revenue growth.

While the stock's price surge reflects optimism, the fundamentals suggest caution. Investors should demand concrete evidence of operational improvements, such as:
- A sustained ROCE above 6% (half the industry average would be a start).
- Margin stabilization or expansion.
- Debt reduction or a clear capital allocation roadmap.

Until then, Volcano Berhad remains a high-risk bet, better suited to speculators than long-term investors. For the latter, waiting for a clearer path to profitability—or a shift in capital strategy—is prudent.

Final Take

Volcano Berhad's declining ROCE and capital mismanagement have painted a bleak picture. While recent revenue gains offer a glimmer of hope, they are outweighed by deteriorating margins and weak earnings quality. The backtest results further highlight the stock's reliance on short-term investor euphoria around earnings releases, which historically fades without tangible progress. Unless the company can demonstrate a turnaround in capital efficiency, investors would be wise to tread carefully. As the old adage goes: Invest in companies that make money, not just those that spend it.