Here's What's Concerning About Hunan Heshun PetroleumLtd's (SHSE:603353) Returns On 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. In light of that, when we looked at Hunan Heshun PetroleumLtd (SHSE:603353) and its ROCE trend, we weren't exactly thrilled.

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

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Hunan Heshun PetroleumLtd is:

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

0.033 = CN¥61m ÷ (CN¥2.1b - CN¥248m) (Based on the trailing twelve months to September 2024).

Thus, Hunan Heshun PetroleumLtd has an ROCE of 3.3%. In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average of 5.0%.

See our latest analysis for Hunan Heshun PetroleumLtd

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're interested in investigating Hunan Heshun PetroleumLtd's past further, check out this free graph covering Hunan Heshun PetroleumLtd's past earnings, revenue and cash flow.

The Trend Of ROCE

When we looked at the ROCE trend at Hunan Heshun PetroleumLtd, we didn't gain much confidence. Around five years ago the returns on capital were 35%, but since then they've fallen to 3.3%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Hunan Heshun PetroleumLtd has done well to pay down its current liabilities to 12% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

In Conclusion...

In summary, we're somewhat concerned by Hunan Heshun PetroleumLtd's diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last three years have experienced a 33% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

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

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.