Investors Met With Slowing Returns on Capital At PETRONAS Dagangan Berhad (KLSE:PETDAG)

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at PETRONAS Dagangan Berhad (KLSE:PETDAG), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

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. The formula for this calculation on PETRONAS Dagangan Berhad is:

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

0.23 = RM1.4b ÷ (RM12b - RM6.2b) (Based on the trailing twelve months to September 2023).

So, PETRONAS Dagangan Berhad has an ROCE of 23%. In absolute terms that's a great return and it's even better than the Oil and Gas industry average of 13%.

Check out our latest analysis for PETRONAS Dagangan Berhad

In the above chart we have measured PETRONAS Dagangan Berhad's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For PETRONAS Dagangan Berhad Tell Us?

Things have been pretty stable at PETRONAS Dagangan Berhad, with its capital employed and returns on that capital staying somewhat the same for the last five years. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. So while the current operations are delivering respectable returns, unless capital employed increases we'd be hard-pressed to believe it's a multi-bagger going forward. That probably explains why PETRONAS Dagangan Berhad has been paying out 90% of its earnings as dividends to shareholders. These mature businesses typically have reliable earnings and not many places to reinvest them, so the next best option is to put the earnings into shareholders pockets.

On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 51% of total assets, this reported ROCE would probably be less than23% because total capital employed would be higher.The 23% ROCE could be even lower if current liabilities weren't 51% of total assets, because the the formula would show a larger base of total capital employed. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.

In Conclusion...

In summary, PETRONAS Dagangan Berhad isn't compounding its earnings but is generating decent returns on the same amount of capital employed. Unsurprisingly then, the total return to shareholders over the last five years has been flat. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

PETRONAS Dagangan Berhad does have some risks though, and we've spotted 1 warning sign for PETRONAS Dagangan Berhad that you might be interested in.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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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.