Are Investors Concerned With What's Going On At China Steel Chemical (TPE:1723)?

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. Having said that, after a brief look, China Steel Chemical (TPE:1723) we aren't filled with optimism, but let's investigate further.

What is 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. The formula for this calculation on China Steel Chemical is:

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

0.094 = NT$728m ÷ (NT$11b - NT$3.7b) (Based on the trailing twelve months to September 2020).

Thus, China Steel Chemical has an ROCE of 9.4%. On its own that's a low return, but compared to the average of 6.7% generated by the Chemicals industry, it's much better.

See our latest analysis for China Steel Chemical

In the above chart we have measured China Steel Chemical'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 China Steel Chemical here for free.

What The Trend Of ROCE Can Tell Us

We are a bit worried about the trend of returns on capital at China Steel Chemical. Unfortunately the returns on capital have diminished from the 21% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on China Steel Chemical becoming one if things continue as they have.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 32%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

Our Take On China Steel Chemical'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. Investors must expect better things on the horizon though because the stock has risen 10% 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 separate note, we've found 3 warning signs for China Steel Chemical you'll probably want to know about.

While China Steel Chemical 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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This article by Simply Wall St is general in nature. 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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