China Automotive Systems' (NASDAQ:CAAS) Returns On Capital Not Reflecting Well On The Business

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. In light of that, from a first glance at China Automotive Systems (NASDAQ:CAAS), we've spotted some signs that it could be struggling, so let's investigate.

Return On Capital Employed (ROCE): What is it?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on China Automotive Systems is:

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

0.0012 = US$439k ÷ (US$696m - US$338m) (Based on the trailing twelve months to June 2021).

So, China Automotive Systems has an ROCE of 0.1%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 11%.

See our latest analysis for China Automotive Systems

Above you can see how the current ROCE for China Automotive Systems compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for China Automotive Systems.

What The Trend Of ROCE Can Tell Us

We are a bit worried about the trend of returns on capital at China Automotive Systems. Unfortunately the returns on capital have diminished from the 7.9% 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. 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 China Automotive Systems becoming one if things continue as they have.

Another thing to note, China Automotive Systems has a high ratio of current liabilities to total assets of 49%. 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

In summary, it's unfortunate that China Automotive Systems is generating lower returns from the same amount of capital. And long term shareholders have watched their investments stay flat over the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you're still interested in China Automotive Systems it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.

While China Automotive Systems 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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