China Tobacco International (HK) (HKG:6055) Will Be Hoping To Turn Its Returns On Capital Around

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? 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. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. And from a first read, things don't look too good at China Tobacco International (HK) (HKG:6055), so let's see why.

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. To calculate this metric for China Tobacco International (HK), this is the formula:

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

0.10 = HK$173m ÷ (HK$2.5b - HK$776m) (Based on the trailing twelve months to June 2021).

Thus, China Tobacco International (HK) has an ROCE of 10%. In absolute terms, that's a satisfactory return, but compared to the Retail Distributors industry average of 4.4% it's much better.

View our latest analysis for China Tobacco International (HK)

Above you can see how the current ROCE for China Tobacco International (HK) compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

The Trend Of ROCE

There is reason to be cautious about China Tobacco International (HK), given the returns are trending downwards. To be more specific, the ROCE was 28% 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 Tobacco International (HK) to turn into a multi-bagger.

On a side note, China Tobacco International (HK) has done well to pay down its current liabilities to 31% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On China Tobacco International (HK)'s ROCE

In summary, it's unfortunate that China Tobacco International (HK) is generating lower returns from the same amount of capital. However the stock has delivered a 15% return to shareholders over the last year, 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.

If you're still interested in China Tobacco International (HK) it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.

While China Tobacco International (HK) 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.

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.

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