Lifestyle International Holdings (HKG:1212) Will Be Hoping To Turn Its Returns On Capital Around

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. In light of that, from a first glance at Lifestyle International Holdings (HKG:1212), we've spotted some signs that it could be struggling, so let's investigate.

Return On Capital Employed (ROCE): What is it?

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 Lifestyle International Holdings, this is the formula:

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

0.052 = HK$781m ÷ (HK$26b - HK$11b) (Based on the trailing twelve months to December 2020).

Therefore, Lifestyle International Holdings has an ROCE of 5.2%. On its own, that's a low figure but it's around the 5.7% average generated by the Multiline Retail industry.

View our latest analysis for Lifestyle International Holdings

In the above chart we have measured Lifestyle International Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Lifestyle International Holdings.

How Are Returns Trending?

The trend of ROCE at Lifestyle International Holdings is showing some signs of weakness. To be more specific, today's ROCE was 8.8% five years ago but has since fallen to 5.2%. In addition to that, Lifestyle International Holdings is now employing 34% 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. 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, Lifestyle International Holdings' current liabilities have increased over the last five years to 42% 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. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Bottom Line

To see Lifestyle International Holdings reducing the capital employed in the business in tandem with diminishing returns, is concerning. Long term shareholders who've owned the stock over the last five years have experienced a 28% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Lifestyle International Holdings (of which 1 is significant!) that you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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