Huadian Power International (HKG:1071) May Have Issues Allocating Its Capital

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? 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. Basically the company is earning less on its investments and it is also reducing its total assets. Having said that, after a brief look, Huadian Power International (HKG:1071) we aren't filled with optimism, but let's investigate further.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Huadian Power International, this is the formula:

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

0.027 = CN¥4.2b ÷ (CN¥218b - CN¥60b) (Based on the trailing twelve months to September 2021).

So, Huadian Power International has an ROCE of 2.7%. In absolute terms, that's a low return and it also under-performs the Renewable Energy industry average of 6.8%.

View our latest analysis for Huadian Power International

In the above chart we have measured Huadian Power International's 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 Huadian Power International.

What The Trend Of ROCE Can Tell Us

In terms of Huadian Power International's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 12% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 Huadian Power International 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. In spite of that, the stock has delivered a 12% return to shareholders who held over the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

If you want to know some of the risks facing Huadian Power International we've found 4 warning signs (1 is significant!) that you should be aware of before investing here.

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.