The Returns On Capital At Hengyuan Refining Company Berhad (KLSE:HENGYUAN) Don't Inspire Confidence

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Hengyuan Refining Company Berhad (KLSE:HENGYUAN), it didn't seem to tick all of these boxes.

What is 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. To calculate this metric for Hengyuan Refining Company Berhad, this is the formula:

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

0.12 = RM319m ÷ (RM4.7b - RM2.1b) (Based on the trailing twelve months to June 2021).

Thus, Hengyuan Refining Company Berhad has an ROCE of 12%. That's a relatively normal return on capital, and it's around the 13% 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're interested in investigating Hengyuan Refining Company Berhad's past further, check out this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

When we looked at the ROCE trend at Hengyuan Refining Company Berhad, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 12% from 21% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, Hengyuan Refining Company Berhad has decreased its current liabilities to 45% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 45% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line On Hengyuan Refining Company Berhad's ROCE

In summary, we're somewhat concerned by Hengyuan Refining Company Berhad's diminishing returns on increasing amounts of capital. Investors must expect better things on the horizon though because the stock has risen 40% in 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.

On a final note, we found 2 warning signs for Hengyuan Refining Company Berhad (1 is significant) you should be aware of.

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.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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