Hengyuan Refining Company Berhad (KLSE:HENGYUAN) Might Be Having Difficulty Using Its Capital Effectively

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Hengyuan Refining Company Berhad (KLSE:HENGYUAN), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

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. Analysts use this formula to calculate it for Hengyuan Refining Company Berhad:

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

0.15 = RM405m ÷ (RM4.9b - RM2.1b) (Based on the trailing twelve months to March 2021).

Thus, Hengyuan Refining Company Berhad has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 8.0% generated by the Oil and Gas industry.

View our latest analysis for Hengyuan Refining Company Berhad

Historical performance is a great place to start when researching a stock so above you can see the gauge for Hengyuan Refining Company Berhad's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Hengyuan Refining Company Berhad, check out these free graphs here.

The Trend Of ROCE

On the surface, the trend of ROCE at Hengyuan Refining Company Berhad doesn't inspire confidence. Around five years ago the returns on capital were 33%, but since then they've fallen to 15%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Hengyuan Refining Company Berhad has decreased its current liabilities to 44% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Bottom Line

From the above analysis, we find it rather worrisome that returns on capital and sales for Hengyuan Refining Company Berhad have fallen, meanwhile the business is employing more capital than it was five years ago. Yet despite these concerning fundamentals, the stock has performed strongly with a 84% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One final note, you should learn about the 2 warning signs we've spotted with Hengyuan Refining Company Berhad (including 1 which is concerning) .

While Hengyuan Refining Company 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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