Union Materials (KRX:047400) Could Be Struggling To Allocate Capital

What underlying fundamental trends can indicate that a company might be in decline? 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 to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. And from a first read, things don't look too good at Union Materials (KRX:047400), so let's see why.

Understanding 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 Union Materials, this is the formula:

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

0.00075 = ₩94m ÷ (₩184b - ₩59b) (Based on the trailing twelve months to December 2020).

So, Union Materials has an ROCE of 0.08%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 4.6%.

See our latest analysis for Union Materials

Historical performance is a great place to start when researching a stock so above you can see the gauge for Union Materials' ROCE against it's prior returns. If you're interested in investigating Union Materials' past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Union Materials Tell Us?

We are a bit worried about the trend of returns on capital at Union Materials. Unfortunately the returns on capital have diminished from the 5.2% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Union Materials becoming one if things continue as they have.

On a side note, Union Materials' current liabilities have increased over the last five years to 32% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 0.08%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

Our Take On Union Materials' 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. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 60% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One more thing, we've spotted 2 warning signs facing Union Materials that you might find interesting.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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This article by Simply Wall St is general in nature. 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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