Capital Allocation Trends At Sinopec Kantons Holdings (HKG:934) Aren't Ideal

What underlying fundamental trends can indicate that a company might be in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. In light of that, from a first glance at Sinopec Kantons Holdings (HKG:934), we've spotted some signs that it could be struggling, so let's investigate.

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. Analysts use this formula to calculate it for Sinopec Kantons Holdings:

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

0.0092 = HK$139m ÷ (HK$15b - HK$234m) (Based on the trailing twelve months to December 2022).

Therefore, Sinopec Kantons Holdings has an ROCE of 0.9%. In absolute terms, that's a low return and it also under-performs the Oil and Gas industry average of 7.0%.

See our latest analysis for Sinopec Kantons Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Sinopec Kantons Holdings' ROCE against it's prior returns. If you'd like to look at how Sinopec Kantons Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

SWOT Analysis for Sinopec Kantons Holdings

What Does the ROCE Trend For Sinopec Kantons Holdings Tell Us?

We are a bit worried about the trend of returns on capital at Sinopec Kantons Holdings. About five years ago, returns on capital were 4.9%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Sinopec Kantons Holdings becoming one if things continue as they have.

On a side note, Sinopec Kantons Holdings has done well to pay down its current liabilities to 1.5% of total assets. That could partly explain why the ROCE has dropped. 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line On Sinopec Kantons Holdings' 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. And, the stock has remained flat over the last five years, so investors don't seem too impressed either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Sinopec Kantons Holdings (of which 2 shouldn't be ignored!) that you should know about.

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. 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.