Hunan Mendale HometextileLtd (SZSE:002397) Has Some Difficulty Using Its Capital Effectively

Simply Wall St · 11/25 23:02

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. And from a first read, things don't look too good at Hunan Mendale HometextileLtd (SZSE:002397), so let's see why.

What Is 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. To calculate this metric for Hunan Mendale HometextileLtd, this is the formula:

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

0.026 = CN¥33m ÷ (CN¥2.6b - CN¥1.4b) (Based on the trailing twelve months to September 2024).

So, Hunan Mendale HometextileLtd has an ROCE of 2.6%. In absolute terms, that's a low return and it also under-performs the Luxury industry average of 6.5%.

See our latest analysis for Hunan Mendale HometextileLtd

roce
SZSE:002397 Return on Capital Employed November 25th 2024

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 want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Hunan Mendale HometextileLtd.

What Can We Tell From Hunan Mendale HometextileLtd's ROCE Trend?

We are a bit anxious about the trends of ROCE at Hunan Mendale HometextileLtd. Unfortunately, returns have declined substantially over the last five years to the 2.6% we see today. In addition to that, Hunan Mendale HometextileLtd is now employing 43% less capital than it was five years ago. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. If these underlying trends continue, we wouldn't be too optimistic going forward.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 53%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 2.6%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

What We Can Learn From Hunan Mendale HometextileLtd's ROCE

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. It should come as no surprise then that the stock has fallen 39% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing: We've identified 2 warning signs with Hunan Mendale HometextileLtd (at least 1 which is significant) , and understanding these would certainly be useful.

While Hunan Mendale HometextileLtd isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.