China ZhengTong Auto Services Holdings' (HKG:1728) Returns On Capital Not Reflecting Well On The Business

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. Basically the company is earning less on its investments and it is also reducing its total assets. On that note, looking into China ZhengTong Auto Services Holdings (HKG:1728), we weren't too upbeat about how things were going.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for China ZhengTong Auto Services Holdings, this is the formula:

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

0.0044 = CN¥39m ÷ (CN¥28b - CN¥19b) (Based on the trailing twelve months to December 2022).

Therefore, China ZhengTong Auto Services Holdings has an ROCE of 0.4%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 9.0%.

View our latest analysis for China ZhengTong Auto Services Holdings

Above you can see how the current ROCE for China ZhengTong Auto Services Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering China ZhengTong Auto Services Holdings here for free.

What Does the ROCE Trend For China ZhengTong Auto Services Holdings Tell Us?

We are a bit anxious about the trends of ROCE at China ZhengTong Auto Services Holdings. The company used to generate 15% on its capital five years ago but it has since fallen noticeably. On top of that, the business is utilizing 45% less capital within its operations. 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. If these underlying trends continue, we wouldn't be too optimistic going forward.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 68%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 0.4%. 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.

What We Can Learn From China ZhengTong Auto Services Holdings' ROCE

To see China ZhengTong Auto Services Holdings reducing the capital employed in the business in tandem with diminishing returns, is concerning. This could explain why the stock has sunk a total of 88% in the last five years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

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

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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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.