McKesson Europe (HMSE:CLS1) Could Be Struggling To Allocate Capital

What underlying fundamental trends can indicate that a company might be in decline? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. So after we looked into McKesson Europe (HMSE:CLS1), the trends above didn't look too great.

What is Return On Capital Employed (ROCE)?

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 McKesson Europe is:

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

0.023 = €74m ÷ (€7.0b - €3.9b) (Based on the trailing twelve months to March 2021).

Thus, McKesson Europe has an ROCE of 2.3%. Ultimately, that's a low return and it under-performs the Healthcare industry average of 7.2%.

Check out our latest analysis for McKesson Europe

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'd like to look at how McKesson Europe has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

The trend of ROCE at McKesson Europe is showing some signs of weakness. The company used to generate 9.5% on its capital five years ago but it has since fallen noticeably. In addition to that, McKesson Europe is now employing 26% less capital than it was five years ago. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

Another thing to note, McKesson Europe has a high ratio of current liabilities to total assets of 55%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

Our Take On McKesson Europe's ROCE

In summary, it's unfortunate that McKesson Europe is shrinking its capital base and also generating lower returns. And long term shareholders have watched their investments stay flat over the last three years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing: We've identified 2 warning signs with McKesson Europe (at least 1 which is significant) , and understanding these would certainly be useful.

While McKesson Europe 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.