Is Chuan Huat Resources Berhad (KLSE:CHUAN) Headed For Trouble?

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. On that note, looking into Chuan Huat Resources Berhad (KLSE:CHUAN), we weren't too upbeat about how things were going.

What is 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 Chuan Huat Resources Berhad, this is the formula:

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

0.013 = RM4.8m ÷ (RM602m - RM249m) (Based on the trailing twelve months to December 2020).

Therefore, Chuan Huat Resources Berhad has an ROCE of 1.3%. In absolute terms, that's a low return and it also under-performs the Trade Distributors industry average of 6.2%.

Check out our latest analysis for Chuan Huat Resources Berhad

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'd like to look at how Chuan Huat Resources Berhad has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

We are a bit worried about the trend of returns on capital at Chuan Huat Resources Berhad. Unfortunately the returns on capital have diminished from the 2.4% that they were earning five years ago. 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. If these trends continue, we wouldn't expect Chuan Huat Resources Berhad to turn into a multi-bagger.

On a separate but related note, it's important to know that Chuan Huat Resources Berhad has a current liabilities to total assets ratio of 41%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

In Conclusion...

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. In spite of that, the stock has delivered a 16% return to shareholders who held over the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

One more thing: We've identified 3 warning signs with Chuan Huat Resources Berhad (at least 2 which shouldn't be ignored) , and understanding them would certainly be useful.

While Chuan Huat Resources Berhad 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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