What These Trends Mean At Hanshin Machinery (KRX:011700)

What underlying fundamental trends can indicate that a company might be in decline? 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. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. Having said that, after a brief look, Hanshin Machinery (KRX:011700) we aren't filled with optimism, but let's investigate further.

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 Hanshin Machinery, this is the formula:

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

0.039 = ₩3.3b ÷ (₩92b - ₩7.6b) (Based on the trailing twelve months to September 2020).

So, Hanshin Machinery has an ROCE of 3.9%. Ultimately, that's a low return and it under-performs the Machinery industry average of 5.4%.

Check out our latest analysis for Hanshin Machinery

Historical performance is a great place to start when researching a stock so above you can see the gauge for Hanshin Machinery's ROCE against it's prior returns. If you'd like to look at how Hanshin Machinery has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From Hanshin Machinery's ROCE Trend?

There is reason to be cautious about Hanshin Machinery, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 12% 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. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Hanshin Machinery becoming one if things continue as they have.

On a side note, Hanshin Machinery has done well to pay down its current liabilities to 8.3% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line On Hanshin Machinery's 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. Investors haven't taken kindly to these developments, since the stock has declined 24% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Hanshin Machinery does have some risks, we noticed 3 warning signs (and 1 which is significant) we think you should know about.

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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