EE-HWA Construction (KOSDAQ:001840) Has Some Difficulty Using Its Capital Effectively

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. And from a first read, things don't look too good at EE-HWA Construction (KOSDAQ:001840), so let's see why.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on EE-HWA Construction is:

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

0.016 = ₩783m ÷ (₩86b - ₩39b) (Based on the trailing twelve months to December 2020).

So, EE-HWA Construction has an ROCE of 1.6%. Ultimately, that's a low return and it under-performs the Construction industry average of 8.4%.

Check out our latest analysis for EE-HWA Construction

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of EE-HWA Construction, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

We are a bit worried about the trend of returns on capital at EE-HWA Construction. Unfortunately the returns on capital have diminished from the 3.1% 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. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect EE-HWA Construction to turn into a multi-bagger.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 45%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 1.6%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Bottom Line

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. Since the stock has skyrocketed 181% over the last five years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

If you'd like to know more about EE-HWA Construction, we've spotted 2 warning signs, and 1 of them makes us a bit uncomfortable.

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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