McKesson Europe (HMSE:CLS1) may struggle to allocate capital

What underlying fundamental trends can indicate that a business might be in decline? Generally, we will see the trend of both to return to on capital employed (ROCE) falling and this usually coincides with a falling quantity capital employed. This indicates that the company is getting less profit from its investments and its total assets are decreasing. So, after considering McKesson Europe (HMSE:CLS1), the above trends didn’t look too good.

What is return on capital employed (ROCE)?

For those who don’t know what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital used in its business. The formula for this calculation on McKesson Europe is:

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

0.023 = €74m ÷ (€7.0bn – €3.9bn) (Based on the last twelve months to March 2021).

Thereby, McKesson Europe posted a ROCE of 2.3%. Ultimately, this is a poor performer and it underperforms the healthcare industry average by 7.2%.

Discover our latest analysis for McKesson Europe

HMSE:CLS1 Return on Capital Employed January 28, 2022

Although the past is not indicative of the future, it can be useful to know the historical performance of a company, which is why we have this graph above. If you want to see how McKesson Europe has performed in the past in other metrics, you can see this free chart of past profits, revenue and cash flow.

The ROCE trend

The ROCE trend at McKesson Europe is showing some signs of weakness. The company generated 9.5% of its capital five years ago but it has since fallen significantly. Additionally, McKesson Europe now employs 26% less capital than five years ago. The combination of lower ROCE and less capital employed may indicate that a company is likely to face competitive headwinds or see an erosion of its moat. Generally, companies with these characteristics are not the ones that tend to multiply over the long term, because statistically speaking, they have already gone through the growth phase of their life cycle.

Another thing to note, McKesson Europe has a high ratio of current liabilities to total assets of 55%. This effectively means that suppliers (or short-term creditors) finance a large part of the business, so just be aware that this may introduce some elements of risk. Although this is not necessarily a bad thing, it can be beneficial if this ratio is lower.

Our view on McKesson Europe’s ROCE

In summary, it is unfortunate that McKesson Europe is reducing its capital base and also generating lower returns. And long-term shareholders have seen their investments stagnate over the past three years. With underlying trends that are not good in these areas, we would consider looking elsewhere.

One more thing: we have identified 2 warning signs with McKesson Europe (at least 1, which is significant), and understanding them would certainly be helpful.

Although McKesson Europe is not currently generating the highest returns, we have compiled a list of companies that are currently generating over 25% return on equity. look at this free list here.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

Mary I. Bruner