Hengan International Group's (HKG:1044) Returns On Capital Not Reflecting Well On The Business

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. On that note, looking into Hengan International Group (HKG:1044), we weren't too upbeat about how things were going.

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. The formula for this calculation on Hengan International Group is:

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

0.14 = CN¥3.1b ÷ (CN¥47b - CN¥25b) (Based on the trailing twelve months to June 2022).

Therefore, Hengan International Group has an ROCE of 14%. That's a relatively normal return on capital, and it's around the 15% generated by the Personal Products industry.

Check out our latest analysis for Hengan International Group

Above you can see how the current ROCE for Hengan International Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Hengan International Group Tell Us?

We are a bit worried about the trend of returns on capital at Hengan International Group. To be more specific, the ROCE was 27% five years ago, but since then it has dropped noticeably. 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 Hengan International Group becoming one if things continue as they have.

On a separate but related note, it's important to know that Hengan International Group has a current liabilities to total assets ratio of 53%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

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. Long term shareholders who've owned the stock over the last five years have experienced a 38% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you want to continue researching Hengan International Group, you might be interested to know about the 2 warning signs that our analysis has discovered.

While Hengan International Group 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. 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.