Here's What's Concerning About China BlueChemical's (HKG:3983) Returns On Capital

What financial metrics can indicate to us that a company is maturing or even in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. 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 China BlueChemical (HKG:3983), we weren't too upbeat about how things were going.

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. To calculate this metric for China BlueChemical, this is the formula:

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

0.044 = CN¥690m ÷ (CN¥21b - CN¥4.9b) (Based on the trailing twelve months to December 2020).

Therefore, China BlueChemical has an ROCE of 4.4%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 9.7%.

View our latest analysis for China BlueChemical

In the above chart we have measured China BlueChemical's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering China BlueChemical here for free.

What Does the ROCE Trend For China BlueChemical Tell Us?

We are a bit worried about the trend of returns on capital at China BlueChemical. To be more specific, the ROCE was 5.6% 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 China BlueChemical to turn into a multi-bagger.

In Conclusion...

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. However the stock has delivered a 92% return to shareholders over the last five years, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

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

While China BlueChemical 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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