Sheen Tai Holdings Group (HKG:1335) Is Finding It Tricky To Allocate Its Capital

What financial metrics can indicate to us that a company is maturing or even in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. On that note, looking into Sheen Tai Holdings Group (HKG:1335), we weren't too upbeat about how things were going.

What is 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 Sheen Tai Holdings Group, this is the formula:

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

0.014 = HK$12m ÷ (HK$882m - HK$27m) (Based on the trailing twelve months to June 2021).

Therefore, Sheen Tai Holdings Group has an ROCE of 1.4%. Ultimately, that's a low return and it under-performs the Packaging industry average of 12%.

See our latest analysis for Sheen Tai Holdings Group

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're interested in investigating Sheen Tai Holdings Group's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

We are a bit anxious about the trends of ROCE at Sheen Tai Holdings Group. To be more specific, today's ROCE was 2.5% five years ago but has since fallen to 1.4%. In addition to that, Sheen Tai Holdings Group is now employing 26% less capital than it was five years ago. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

On a side note, Sheen Tai Holdings Group has done well to pay down its current liabilities to 3.1% of total assets. That could partly explain why the ROCE has dropped. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

In Conclusion...

In summary, it's unfortunate that Sheen Tai Holdings Group is shrinking its capital base and also generating lower returns. We expect this has contributed to the stock plummeting 80% during the last five years. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you'd like to know about the risks facing Sheen Tai Holdings Group, we've discovered 1 warning sign that you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.