Be Wary Of Tibet Water Resources (HKG:1115) And Its Returns On Capital

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? More often than not, we'll see a declining return on capital employed (ROCE) and a declining 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. In light of that, from a first glance at Tibet Water Resources (HKG:1115), we've spotted some signs that it could be struggling, so let's investigate.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Tibet Water Resources, this is the formula:

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

0.033 = CN¥97m ÷ (CN¥4.3b - CN¥1.4b) (Based on the trailing twelve months to June 2020).

So, Tibet Water Resources has an ROCE of 3.3%. In absolute terms, that's a low return and it also under-performs the Beverage industry average of 8.2%.

Check out our latest analysis for Tibet Water Resources

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Tibet Water Resources has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From Tibet Water Resources' ROCE Trend?

There is reason to be cautious about Tibet Water Resources, given the returns are trending downwards. To be more specific, the ROCE was 13% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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 Tibet Water Resources becoming one if things continue as they have.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 32%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 3.3%. 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.

The Key Takeaway

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Unsurprisingly then, the stock has dived 75% over the last five years, so investors are recognizing these changes and don't like the company's prospects. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Tibet Water Resources does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is significant...

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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