Why Steelcase Inc (NYSE: SCS) ROE of 10% Doesn’t Tell The Whole Story


Steelcase Inc. (NYSE: SCS) underperformed the Industrials sector by -0.4% as it relates to ROE, producing a low 10.2% compared to the sector’s 10.6%. But what is more interesting is whether Steelcase will continue to post subpar returns moving forward. The DuPont analysis is a useful tool that may help us determine this. In my analysis below, I’ll use the DuPont model to reveal what’s really driving the company’s low ROE.

Steelcase’s ROE Trends

Return on equity or ROE represents the percentage return a company generates on the money shareholders have invested.

ROE = Net Income To Common / Average Total Common Equity

In general, a higher return on equity suggests management is utilizing the capital invested by shareholders efficiently. However, it is important to note that ROE can be impacted by management’s financing decisions such as the deployment of leverage.

Steelcase’s recent ROE trends are illustrated in the chart below.

Steelcase's ROE Trends Chart

source: finbox.io data explorer – ROE

Unfortunately for shareholders, Steelcase’s return on equity has decreased each year since 2016. ROE decreased from 24.3% to 16.6% in fiscal year 2017, decreased to 10.2% in 2018 and the LTM period is also its latest fiscal year. So what’s causing the steady decline?

What’s Causing Steelcase’s Declining Return On Equity

A less used approach although being much more intuitive, the DuPont formula is another way to calculate a company’s ROE. It is defined as:

ROE = Net Profit Margin * Asset Turnover * Equity Multiplier

Created by the DuPont Corporation in the 1920s, the analysis is a useful tool that helps determine what’s responsible for changes in a company’s ROE. It highlights that a firm’s ROE is affected by three things: profit margin, asset turnover, and its equity multiplier or financial leverage.

Analyzing changes in these three items over time allows investors to figure out if operating efficiency, asset use efficiency or the use of leverage is what’s causing changes in ROE. Strong companies should have ROE that is increasing because its net profit margin and/or asset turnover is increasing. On the other hand, a company may not be as strong as investors would otherwise think if ROE is increasing from the use of leverage or debt.

So let’s take a closer look at what’s causing Steelcase’s declining returns.

Steelcase’s Net Profit Margin Trends

Unfortunately for shareholders, Steelcase’s net profit margin has decreased each year since 2016. Margins decreased from 5.6% to 4.1% in fiscal year 2017, decreased to 2.6% in 2018 and the LTM period is also its latest fiscal year.

SCS Net Profit Margin Trends

source: data explorer – net profit margin

As a result, the company’s worsening margins help explain, at least in part, why ROE continues to decline. However, let’s also take a look at Steelcase’s efficiency.

Steelcase’s Asset Turnover Trends

Unfortunately for shareholders, Steelcase’s asset turnover has decreased each year since 2016. Turnover decreased from 1.73x to 1.68x in fiscal year 2017, decreased to 1.67x in 2018 and the LTM period is also its latest fiscal year.

SCS Asset Turnover Trends

source: data explorer – asset turnover

As a result, the company’s worsening asset turnover ratio helps explain, at least partially, why ROE continues to decline.

Finally, the DuPont constituents that make up Steelcase’s ROE are shown in the table below. Note that the table also compares Steelcase to a peer group that includes HNI Corporation(NYSE: HNI), Knoll, Inc. (NYSE: KNL), Pitney Bowes Inc. (NYSE: PBI) and STERIS plc (NYSE: STE).

SCS ROE Breakdown vs Peers Table - DuPont Analysis

source: finbox.io’s DuPont model

In conclusion, the DuPont analysis has helped us better understand that Steelcase’s continuous fall in return on equity is the result of a steadily deteriorating net profit margin, a declining asset turnover ratio and declining leverage. Therefore when looking at the core operations of the business, Steelcase shareholders have reason to be concerned due to the company’s deteriorating profitability along with deteriorating operational efficiency and declining leverage.

The DuPont approach is a helpful tool when analyzing how well management is utilizing shareholder capital. However, it doesn’t necessarily tell the whole story. For example, how do the company’s ROE trends compare to its peers or sector? How about in absolute returns? I recommend that investors continue to research Steelcase to gain a better understanding of its fundamentals before making an investment decision.

As of this writing, I did not hold a position in any of the aforementioned securities and this is not a buy or sell recommendation on any security mentioned.

Expertise: Valuation, financial statement analysis. Matt Hogan is also a co-founder of finbox.io. His expertise is in investment decision making. Prior to finbox.io, Matt worked for an investment banking group providing fairness opinions in connection to stock acquisitions. He spent much of his time building valuation models to help clients determine an asset’s fair value. He believes that these same valuation models should be used by all investors before buying or selling a stock. His work is frequently published at InvestorPlace, Benzinga, ValueWalk, AAII, Barron’s, Seeking Alpha and investing.com. Matt can be reached at matt@finbox.io or at +1 (516) 778-6257.

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