Hengli PetrochemicalLtd (SHSE:600346) Could Be Struggling To Allocate Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think Hengli PetrochemicalLtd (SHSE:600346) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Hengli PetrochemicalLtd, this is the formula:

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

0.088 = CN¥13b ÷ (CN¥272b - CN¥129b) (Based on the trailing twelve months to September 2024).

So, Hengli PetrochemicalLtd has an ROCE of 8.8%. On its own that's a low return, but compared to the average of 5.6% generated by the Chemicals industry, it's much better.

See our latest analysis for Hengli PetrochemicalLtd

Above you can see how the current ROCE for Hengli PetrochemicalLtd compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Hengli PetrochemicalLtd .

The Trend Of ROCE

In terms of Hengli PetrochemicalLtd's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 8.8% from 13% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Hengli PetrochemicalLtd's current liabilities are still rather high at 47% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

In Conclusion...

In summary, Hengli PetrochemicalLtd is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors may be recognizing these trends since the stock has only returned a total of 19% to shareholders over the last five years. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Hengli PetrochemicalLtd (of which 1 doesn't sit too well with us!) that you should know about.

While Hengli PetrochemicalLtd 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.