Capital Allocation Trends At Hilong Holding (HKG:1623) Aren't Ideal

What financial metrics can indicate to us that a company is maturing or even in decline? 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. Basically the company is earning less on its investments and it is also reducing its total assets. Having said that, after a brief look, Hilong Holding (HKG:1623) we aren't filled with optimism, but let's investigate further.

Understanding 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. Analysts use this formula to calculate it for Hilong Holding:

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

0.052 = CN¥170m ÷ (CN¥7.4b - CN¥4.1b) (Based on the trailing twelve months to December 2020).

Thus, Hilong Holding has an ROCE of 5.2%. On its own that's a low return, but compared to the average of 4.2% generated by the Energy Services industry, it's much better.

See our latest analysis for Hilong Holding

Above you can see how the current ROCE for Hilong Holding compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Hilong Holding.

What Can We Tell From Hilong Holding's ROCE Trend?

We are a bit anxious about the trends of ROCE at Hilong Holding. To be more specific, today's ROCE was 7.7% five years ago but has since fallen to 5.2%. In addition to that, Hilong Holding is now employing 27% less capital than it was five years ago. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

On a side note, Hilong Holding's current liabilities have increased over the last five years to 56% 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. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

In Conclusion...

In summary, it's unfortunate that Hilong Holding is shrinking its capital base and also generating lower returns. We expect this has contributed to the stock plummeting 78% during the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing: We've identified 3 warning signs with Hilong Holding (at least 1 which is a bit unpleasant) , and understanding these would certainly be useful.

While Hilong Holding may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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