Kawasaki Heavy Industries (TSE:7012) Has Some Difficulty Using Its Capital Effectively

What underlying fundamental trends can indicate that a company might be in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. Having said that, after a brief look, Kawasaki Heavy Industries (TSE:7012) we aren't filled with optimism, but let's investigate further.

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. Analysts use this formula to calculate it for Kawasaki Heavy Industries:

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

0.031 = JP¥35b ÷ (JP¥2.7t - JP¥1.5t) (Based on the trailing twelve months to March 2024).

Therefore, Kawasaki Heavy Industries has an ROCE of 3.1%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 8.0%.

View our latest analysis for Kawasaki Heavy Industries

Above you can see how the current ROCE for Kawasaki Heavy Industries compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Kawasaki Heavy Industries .

How Are Returns Trending?

There is reason to be cautious about Kawasaki Heavy Industries, given the returns are trending downwards. To be more specific, the ROCE was 6.6% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Kawasaki Heavy Industries becoming one if things continue as they have.

On a side note, Kawasaki Heavy Industries' current liabilities have increased over the last five years to 58% 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.

What We Can Learn From Kawasaki Heavy Industries' ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 141%. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Kawasaki Heavy Industries does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those is significant...

While Kawasaki Heavy Industries 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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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.