China Mengniu Dairy (HKG:2319) Will Want To Turn Around Its Return Trends

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think China Mengniu Dairy (HKG:2319) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. Analysts use this formula to calculate it for China Mengniu Dairy:

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

0.054 = CN¥4.6b ÷ (CN¥118b - CN¥33b) (Based on the trailing twelve months to December 2022).

Thus, China Mengniu Dairy has an ROCE of 5.4%. In absolute terms, that's a low return and it also under-performs the Food industry average of 9.8%.

See our latest analysis for China Mengniu Dairy

In the above chart we have measured China Mengniu Dairy's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering China Mengniu Dairy here for free.

What Does the ROCE Trend For China Mengniu Dairy Tell Us?

On the surface, the trend of ROCE at China Mengniu Dairy doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.4% from 8.8% five years ago. However it looks like China Mengniu Dairy might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, China Mengniu Dairy has done well to pay down its current liabilities to 28% of total assets. So we could link some of this to the decrease in ROCE. 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

Bringing it all together, while we're somewhat encouraged by China Mengniu Dairy's reinvestment in its own business, we're aware that returns are shrinking. And investors may be recognizing these trends since the stock has only returned a total of 17% to shareholders over the last five years. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

China Mengniu Dairy could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.

While China Mengniu Dairy isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.