How Has China Pioneer Pharma Holdings (HKG:1345) Allocated Its Capital?

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. 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. This indicates the company is producing less profit from its investments and its total assets are decreasing. In light of that, from a first glance at China Pioneer Pharma Holdings (HKG:1345), we've spotted some signs that it could be struggling, so let's investigate.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for China Pioneer Pharma Holdings, this is the formula:

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

0.12 = CN¥114m ÷ (CN¥1.2b - CN¥281m) (Based on the trailing twelve months to June 2020).

So, China Pioneer Pharma Holdings has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Healthcare industry average of 8.4% it's much better.

View our latest analysis for China Pioneer Pharma Holdings

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 China Pioneer Pharma Holdings 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 China Pioneer Pharma Holdings' ROCE Trend?

There is reason to be cautious about China Pioneer Pharma Holdings, given the returns are trending downwards. About five years ago, returns on capital were 25%, 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. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on China Pioneer Pharma Holdings becoming one if things continue as they have.

On a side note, China Pioneer Pharma Holdings has done well to pay down its current liabilities to 23% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From China Pioneer Pharma Holdings' ROCE

In summary, it's unfortunate that China Pioneer Pharma Holdings is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 16% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

China Pioneer Pharma Holdings does have some risks, we noticed 4 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

While China Pioneer Pharma Holdings 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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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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