Royal Deluxe Holdings (HKG:3789) May Have Issues Allocating Its Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Royal Deluxe Holdings (HKG:3789) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. The formula for this calculation on Royal Deluxe Holdings is:

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

0.088 = HK$24m ÷ (HK$474m - HK$205m) (Based on the trailing twelve months to September 2020).

Thus, Royal Deluxe Holdings has an ROCE of 8.8%. Even though it's in line with the industry average of 9.1%, it's still a low return by itself.

Check out our latest analysis for Royal Deluxe Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Royal Deluxe Holdings' ROCE against it's prior returns. If you're interested in investigating Royal Deluxe Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Royal Deluxe Holdings' ROCE Trend?

On the surface, the trend of ROCE at Royal Deluxe Holdings doesn't inspire confidence. Over the last five years, returns on capital have decreased to 8.8% from 48% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Royal Deluxe Holdings has done well to pay down its current liabilities to 43% of total assets. So we could link some of this to the decrease in ROCE. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Key Takeaway

While returns have fallen for Royal Deluxe Holdings in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, despite the promising trends, the stock has fallen 68% over the last three years, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One more thing: We've identified 6 warning signs with Royal Deluxe Holdings (at least 1 which is significant) , and understanding these would certainly be useful.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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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