Is This A Sign of Things To Come At Melati Ehsan Holdings Berhad (KLSE:MELATI)?

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. Basically the company is earning less on its investments and it is also reducing its total assets. In light of that, from a first glance at Melati Ehsan Holdings Berhad (KLSE:MELATI), we've spotted some signs that it could be struggling, so let's investigate.

Return On Capital Employed (ROCE): What is it?

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. Analysts use this formula to calculate it for Melati Ehsan Holdings Berhad:

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

0.037 = RM7.9m ÷ (RM373m - RM160m) (Based on the trailing twelve months to November 2020).

So, Melati Ehsan Holdings Berhad has an ROCE of 3.7%. Ultimately, that's a low return and it under-performs the Construction industry average of 4.9%.

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 want to delve into the historical earnings, revenue and cash flow of Melati Ehsan Holdings Berhad, check out these free graphs here.

What Can We Tell From Melati Ehsan Holdings Berhad's ROCE Trend?

We are a bit worried about the trend of returns on capital at Melati Ehsan Holdings Berhad. About five years ago, returns on capital were 5.9%, 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. 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. If these trends continue, we wouldn't expect Melati Ehsan Holdings Berhad to turn into a multi-bagger.

Another thing to note, Melati Ehsan Holdings Berhad has a high ratio of current liabilities to total assets of 43%. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From Melati Ehsan Holdings Berhad's ROCE

In summary, it's unfortunate that Melati Ehsan Holdings Berhad is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 30% 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 is potentially serious) we think you should know about.

While Melati Ehsan Holdings Berhad isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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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