Yahoo Finance McKesson Europe (HMSE:CLS1) Has Some Difficulty Using Its Capital Effectively
When researching a stock for investment, what can tell us that the company is in decline? 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 indicates the company is producing less profit from its investments and its total assets are decreasing. On that note, looking into McKesson Europe (HMSE:CLS1), 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. Analysts use this formula to calculate it for McKesson Europe:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.024 = €69m ÷ (€5.1b - €2.3b) (Based on the trailing twelve months to March 2022).
Thus, McKesson Europe has an ROCE of 2.4%. In absolute terms, that's a low return and it also under-performs the Healthcare industry average of 5.9%.
See our latest analysis for McKesson Europe
Historical performance is a great place to start when researching a stock so above you can see the gauge for McKesson Europe's ROCE against it's prior returns. If you're interested in investigating McKesson Europe's past further, check out this free graph of past earnings, revenue and cash flow.
So How Is McKesson Europe's ROCE Trending?
We are a bit worried about the trend of returns on capital at McKesson Europe. About five years ago, returns on capital were 9.1%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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 McKesson Europe becoming one if things continue as they have.
On a related note, McKesson Europe has decreased its current liabilities to 45% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.
The Bottom Line
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. In spite of that, the stock has delivered a 8.5% return to shareholders who held over 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.
Like most companies, McKesson Europe does come with some risks, and we've found 2 warning signs that you should be aware of.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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.
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