NagaCorp (HKG:3918) Has Some Difficulty Using Its Capital Effectively

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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 reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after we looked into NagaCorp (HKG:3918), the trends above didn't look too great.

What Is 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 NagaCorp is:

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

0.094 = US$196m ÷ (US$2.8b - US$653m) (Based on the trailing twelve months to December 2023).

So, NagaCorp has an ROCE of 9.4%. On its own that's a low return, but compared to the average of 6.2% generated by the Hospitality industry, it's much better.

Check out our latest analysis for NagaCorp

Above you can see how the current ROCE for NagaCorp compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering NagaCorp for free.

So How Is NagaCorp's ROCE Trending?

There is reason to be cautious about NagaCorp, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 22% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect NagaCorp to turn into a multi-bagger.

On a side note, NagaCorp's current liabilities have increased over the last five years to 24% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 9.4%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

Our Take On NagaCorp's ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Long term shareholders who've owned the stock over the last five years have experienced a 64% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you're still interested in NagaCorp it's worth checking out our FREE intrinsic value approximation for 3918 to see if it's trading at an attractive price in other respects.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com