Is Hong Leong Asia (SGX:H22) Struggling?

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. On that note, looking into Hong Leong Asia (SGX:H22), we weren't too upbeat about how things were going.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Hong Leong Asia, this is the formula:

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

0.049 = S$142m ÷ (S$5.8b - S$2.9b) (Based on the trailing twelve months to June 2020).

Therefore, Hong Leong Asia has an ROCE of 4.9%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 6.3%.

Check out our latest analysis for Hong Leong Asia

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'd like to look at how Hong Leong Asia has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Hong Leong Asia Tell Us?

We are a bit worried about the trend of returns on capital at Hong Leong Asia. To be more specific, the ROCE was 8.4% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Hong Leong Asia to turn into a multi-bagger.

On a separate but related note, it's important to know that Hong Leong Asia has a current liabilities to total assets ratio of 50%, which we'd consider pretty high. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Despite the concerning underlying trends, the stock has actually gained 23% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

On a separate note, we've found 2 warning signs for Hong Leong Asia you'll probably want to know about.

While Hong Leong Asia 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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