Does Melati Ehsan Holdings Berhad's (KLSE:MELATI) Returns On Capital Reflect Well On The Business?

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after we looked into Melati Ehsan Holdings Berhad (KLSE:MELATI), the trends above didn't look too great.

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. The formula for this calculation on Melati Ehsan Holdings Berhad is:

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

0.019 = RM4.1m ÷ (RM386m - RM172m) (Based on the trailing twelve months to August 2020).

So, Melati Ehsan Holdings Berhad has an ROCE of 1.9%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 5.0%.

Check out our latest analysis for Melati Ehsan Holdings 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're interested in investigating Melati Ehsan Holdings Berhad's past further, check out this free graph of past earnings, revenue and cash flow.

So How Is Melati Ehsan Holdings Berhad's ROCE Trending?

In terms of Melati Ehsan Holdings Berhad's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 7.8%, however they're now substantially lower than that as we saw above. 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 Melati Ehsan Holdings Berhad to turn into a multi-bagger.

On a side note, Melati Ehsan Holdings Berhad's current liabilities are still rather high at 45% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

In Conclusion...

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. It should come as no surprise then that the stock has fallen 45% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Melati Ehsan Holdings Berhad does have some risks, we noticed 3 warning signs (and 1 which can't be ignored) we think you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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