The Returns On Capital At Starlite Holdings (HKG:403) Don't Inspire Confidence

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base 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 Starlite Holdings (HKG:403), we weren't too upbeat about how things were going.

What is Return On Capital Employed (ROCE)?

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 Starlite Holdings is:

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

0.029 = HK$11m ÷ (HK$1.1b - HK$713m) (Based on the trailing twelve months to September 2020).

So, Starlite Holdings has an ROCE of 2.9%. In absolute terms, that's a low return and it also under-performs the Packaging industry average of 8.1%.

Check out our latest analysis for Starlite Holdings

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 want to delve into the historical earnings, revenue and cash flow of Starlite Holdings, check out these free graphs here.

What Does the ROCE Trend For Starlite Holdings Tell Us?

We are a bit anxious about the trends of ROCE at Starlite Holdings. To be more specific, today's ROCE was 7.2% five years ago but has since fallen to 2.9%. In addition to that, Starlite Holdings is now employing 44% less capital than it was five years ago. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. If these underlying trends continue, we wouldn't be too optimistic going forward.

On a side note, Starlite Holdings' current liabilities have increased over the last five years to 66% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Key Takeaway

In summary, it's unfortunate that Starlite Holdings is shrinking its capital base and also generating lower returns. It should come as no surprise then that the stock has fallen 39% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you want to know some of the risks facing Starlite Holdings we've found 3 warning signs (1 can't be ignored!) that you should be aware of before investing here.

While Starlite 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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