Be Wary Of Heavitree Brewery (LON:HVTA) And Its Returns On Capital

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? 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. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. So after we looked into Heavitree Brewery (LON:HVTA), 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. To calculate this metric for Heavitree Brewery, this is the formula:

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

0.06 = UK£1.1m ÷ (UK£20m - UK£2.6m) (Based on the trailing twelve months to April 2022).

So, Heavitree Brewery has an ROCE of 6.0%. In absolute terms, that's a low return but it's around the Hospitality industry average of 6.8%.

Our analysis indicates that HVTA is potentially undervalued!

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 Heavitree Brewery's past further, check out this free graph of past earnings, revenue and cash flow.

So How Is Heavitree Brewery's ROCE Trending?

We are a bit worried about the trend of returns on capital at Heavitree Brewery. Unfortunately the returns on capital have diminished from the 8.2% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Heavitree Brewery becoming one if things continue as they have.

In Conclusion...

In summary, it's unfortunate that Heavitree Brewery is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 31% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One final note, you should learn about the 4 warning signs we've spotted with Heavitree Brewery (including 1 which shouldn't be ignored) .

While Heavitree Brewery 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. 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.