The Returns On Capital At NagaCorp (HKG:3918) Don't Inspire Confidence

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at NagaCorp (HKG:3918) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What is it?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on NagaCorp is:

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

0.079 = US$165m ÷ (US$2.5b - US$467m) (Based on the trailing twelve months to December 2020).

Therefore, NagaCorp has an ROCE of 7.9%. On its own that's a low return, but compared to the average of 2.6% generated by the Hospitality industry, it's much better.

Check out our latest analysis for NagaCorp

In the above chart we have measured NagaCorp's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for NagaCorp.

How Are Returns Trending?

On the surface, the trend of ROCE at NagaCorp doesn't inspire confidence. Over the last five years, returns on capital have decreased to 7.9% from 27% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, NagaCorp's current liabilities have increased over the last five years to 18% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

What We Can Learn From NagaCorp's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for NagaCorp have fallen, meanwhile the business is employing more capital than it was five years ago. Yet despite these concerning fundamentals, the stock has performed strongly with a 86% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

One more thing to note, we've identified 3 warning signs with NagaCorp and understanding these should be part of your investment process.

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. 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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