Zhengye International Holdings (HKG:3363) Is Reinvesting At Lower Rates Of Return

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Zhengye International Holdings (HKG:3363) and its ROCE trend, we weren't exactly thrilled.

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. To calculate this metric for Zhengye International Holdings, this is the formula:

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

0.12 = CN¥218m ÷ (CN¥3.1b - CN¥1.3b) (Based on the trailing twelve months to June 2022).

So, Zhengye International Holdings has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Packaging industry average of 8.2% it's much better.

Check out the opportunities and risks within the HK Packaging industry.

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 Zhengye International Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Zhengye International Holdings, we didn't gain much confidence. To be more specific, ROCE has fallen from 21% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Zhengye International Holdings has decreased its current liabilities to 42% 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. 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Bottom Line On Zhengye International Holdings' ROCE

While returns have fallen for Zhengye International Holdings in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, despite the promising trends, the stock has fallen 66% over the last five years, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Zhengye International Holdings (of which 2 are significant!) that you should know about.

While Zhengye International 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. 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.