XinJiang GuoTong PipelineLtd (SZSE:002205) May Have Issues Allocating Its Capital

When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. On that note, looking into XinJiang GuoTong PipelineLtd (SZSE:002205), we weren't too upbeat about how things were going.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on XinJiang GuoTong PipelineLtd is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.00043 = CN¥881k ÷ (CN¥4.1b - CN¥2.0b) (Based on the trailing twelve months to September 2024).

So, XinJiang GuoTong PipelineLtd has an ROCE of 0.04%. In absolute terms, that's a low return and it also under-performs the Building industry average of 7.3%.

See our latest analysis for XinJiang GuoTong PipelineLtd

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of XinJiang GuoTong PipelineLtd.

The Trend Of ROCE

We are a bit worried about the trend of returns on capital at XinJiang GuoTong PipelineLtd. To be more specific, the ROCE was 1.4% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on XinJiang GuoTong PipelineLtd becoming one if things continue as they have.

On a side note, XinJiang GuoTong PipelineLtd's current liabilities have increased over the last five years to 50% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

In Conclusion...

In summary, it's unfortunate that XinJiang GuoTong PipelineLtd is generating lower returns from the same amount of capital. Investors must expect better things on the horizon though because the stock has risen 6.7% in the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

Like most companies, XinJiang GuoTong PipelineLtd does come with some risks, and we've found 1 warning sign that you should be aware of.

While XinJiang GuoTong PipelineLtd may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.