If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. And from a first read, things don't look too good at China Southern Airlines (HKG:1055), so let's see why.

Understanding 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. Analysts use this formula to calculate it for China Southern Airlines:

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

0.019 = CN¥3.5b ÷ (CN¥316b - CN¥136b) (Based on the trailing twelve months to September 2024).

Thus, China Southern Airlines has an ROCE of 1.9%. Ultimately, that's a low return and it under-performs the Airlines industry average of 8.0%.

Check out our latest analysis for China Southern Airlines

Above you can see how the current ROCE for China Southern Airlines compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering China Southern Airlines for free.

What Does the ROCE Trend For China Southern Airlines Tell Us?

There is reason to be cautious about China Southern Airlines, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 4.8% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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. If these trends continue, we wouldn't expect China Southern Airlines to turn into a multi-bagger.

On a side note, China Southern Airlines' current liabilities have increased over the last five years to 43% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. 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.

The Key Takeaway

In summary, it's unfortunate that China Southern Airlines is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 14% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

While China Southern Airlines doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation for 1055 on our platform.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.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.