McKesson Europe (HMSE:CLS1) Will Be Looking To Turn Around Its Returns

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. In light of that, from a first glance at McKesson Europe (HMSE:CLS1), we've spotted some signs that it could be struggling, so let's investigate.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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)

0.027 = €83m ÷ (€7.9b - €4.9b) (Based on the trailing twelve months to March 2020).

Therefore, McKesson Europe has an ROCE of 2.7%. Ultimately, that's a low return and it under-performs the Healthcare industry average of 6.6%.

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 want to delve into the historical earnings, revenue and cash flow of McKesson Europe, check out these free graphs here.

So How Is McKesson Europe's ROCE Trending?

In terms of McKesson Europe's historical ROCE trend, it isn't fantastic. Unfortunately, returns have declined substantially over the last five years to the 2.7% we see today. On top of that, the business is utilizing 29% less capital within its operations. The fact that both are shrinking is an indication that the business is going through some tough times. 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.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 62%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 2.7%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Bottom Line

To see McKesson Europe reducing the capital employed in the business in tandem with diminishing returns, is concerning. Despite the concerning underlying trends, the stock has actually gained 3.3% over the last three years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

McKesson Europe does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those can't be ignored...

While McKesson Europe isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. 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.
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