Hengan International Group's (HKG:1044) Returns On Capital Tell Us There Is Reason To Feel Uneasy

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This indicates the company is producing less profit from its investments and its total assets are decreasing. And from a first read, things don't look too good at Hengan International Group (HKG:1044), so let's see why.

Return On Capital Employed (ROCE): What Is It?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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)

0.16 = CN¥3.7b ÷ (CN¥46b - CN¥23b) (Based on the trailing twelve months to June 2024).

Therefore, Hengan International Group has an ROCE of 16%. That's a relatively normal return on capital, and it's around the 13% 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'd like, you can check out the forecasts from the analysts covering Hengan International Group for free.

The Trend Of ROCE

There is reason to be cautious about Hengan International Group, given the returns are trending downwards. To be more specific, the ROCE was 22% 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. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Hengan International Group to turn into a multi-bagger.

Another thing to note, Hengan International Group has a high ratio of current liabilities to total assets of 49%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

In summary, it's unfortunate that Hengan International Group is generating lower returns from the same amount of capital. Long term shareholders who've owned the stock over the last five years have experienced a 49% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One more thing to note, we've identified 1 warning sign with Hengan International Group and understanding it should be part of your investment process.

While Hengan International Group 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.