Orica (ASX:ORI) Could Be Struggling To Allocate Capital

When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. 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 the company is producing less profit from its investments and its total assets are decreasing. Having said that, after a brief look, Orica (ASX:ORI) we aren't filled with optimism, but let's investigate further.

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 Orica:

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

0.05 = AU$331m ÷ (AU$8.2b - AU$1.5b) (Based on the trailing twelve months to March 2021).

Thus, Orica has an ROCE of 5.0%. In absolute terms, that's a low return but it's around the Chemicals industry average of 4.2%.

Check out our latest analysis for Orica

Above you can see how the current ROCE for Orica 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 Orica here for free.

What Can We Tell From Orica's ROCE Trend?

In terms of Orica's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 11% 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. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Orica becoming one if things continue as they have.

What We Can Learn From Orica's ROCE

In summary, it's unfortunate that Orica is generating lower returns from the same amount of capital. Despite the concerning underlying trends, the stock has actually gained 5.1% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

One more thing: We've identified 3 warning signs with Orica (at least 1 which is potentially serious) , and understanding them would certainly be useful.

While Orica 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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