Some Investors May Be Worried About SINOPEC Engineering (Group)'s (HKG:2386) Returns On Capital

What underlying fundamental trends can indicate that a company might be in decline? 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 the company is producing less profit from its investments and its total assets are decreasing. On that note, looking into SINOPEC Engineering (Group) (HKG:2386), we weren't too upbeat about how things were going.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for SINOPEC Engineering (Group), this is the formula:

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

0.047 = CN¥1.5b ÷ (CN¥79b - CN¥46b) (Based on the trailing twelve months to December 2022).

So, SINOPEC Engineering (Group) has an ROCE of 4.7%. Ultimately, that's a low return and it under-performs the Construction industry average of 6.3%.

View our latest analysis for SINOPEC Engineering (Group)

In the above chart we have measured SINOPEC Engineering (Group)'s prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

We are a bit worried about the trend of returns on capital at SINOPEC Engineering (Group). About five years ago, returns on capital were 5.9%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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 SINOPEC Engineering (Group) becoming one if things continue as they have.

On a separate but related note, it's important to know that SINOPEC Engineering (Group) has a current liabilities to total assets ratio of 59%, which we'd consider pretty high. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line On SINOPEC Engineering (Group)'s ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Long term shareholders who've owned the stock over the last five years have experienced a 33% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

SINOPEC Engineering (Group) does have some risks though, and we've spotted 1 warning sign for SINOPEC Engineering (Group) that you might be interested in.

While SINOPEC Engineering (Group) 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.