Advanced Petrochemical (TADAWUL:2330) Could Be Struggling To Allocate Capital

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. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. Having said that, after a brief look, Advanced Petrochemical (TADAWUL:2330) we aren't filled with optimism, but let's investigate further.

Understanding Return On Capital Employed (ROCE)

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. To calculate this metric for Advanced Petrochemical, this is the formula:

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

0.12 = ر.س554m ÷ (ر.س6.6b - ر.س2.0b) (Based on the trailing twelve months to September 2022).

Therefore, Advanced Petrochemical has an ROCE of 12%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Chemicals industry average of 11%.

See our latest analysis for Advanced Petrochemical

In the above chart we have measured Advanced Petrochemical's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Advanced Petrochemical here for free.

So How Is Advanced Petrochemical's ROCE Trending?

There is reason to be cautious about Advanced Petrochemical, given the returns are trending downwards. About five years ago, returns on capital were 17%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Advanced Petrochemical becoming one if things continue as they have.

On a side note, Advanced Petrochemical's current liabilities have increased over the last five years to 30% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 12%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

Our Take On Advanced Petrochemical's ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 49% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

One more thing: We've identified 4 warning signs with Advanced Petrochemical (at least 2 which don't sit too well with us) , and understanding these would certainly be useful.

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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.