Chr. Hansen Holding (CPH:CHR) Could Be Struggling To Allocate Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Chr. Hansen Holding (CPH:CHR), we don't think it's current trends fit the mold of a multi-bagger.

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. The formula for this calculation on Chr. Hansen Holding is:

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

0.15 = €321m ÷ (€3.2b - €1.0b) (Based on the trailing twelve months to February 2021).

So, Chr. Hansen Holding has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 10% it's much better.

See our latest analysis for Chr. Hansen Holding

Above you can see how the current ROCE for Chr. Hansen Holding compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Chr. Hansen Holding.

What Can We Tell From Chr. Hansen Holding's ROCE Trend?

On the surface, the trend of ROCE at Chr. Hansen Holding doesn't inspire confidence. To be more specific, ROCE has fallen from 19% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Chr. Hansen Holding's current liabilities have increased over the last five years to 32% 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. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

The Key Takeaway

In summary, despite lower returns in the short term, we're encouraged to see that Chr. Hansen Holding is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 44% over the last five years, it would appear that investors are upbeat about the future. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

If you'd like to know more about Chr. Hansen Holding, we've spotted 2 warning signs, and 1 of them can't be ignored.

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

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