Here's What's Concerning About Chennai Petroleum's (NSE:CHENNPETRO) Returns On Capital

When researching a stock for investment, what can tell us that the company is in decline? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. So after glancing at the trends within Chennai Petroleum (NSE:CHENNPETRO), we weren't too hopeful.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Chennai Petroleum:

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

0.21 = ₹12b ÷ (₹164b - ₹106b) (Based on the trailing twelve months to December 2021).

So, Chennai Petroleum has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Oil and Gas industry average of 9.9%.

View our latest analysis for Chennai Petroleum

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Chennai Petroleum's past further, check out this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

In terms of Chennai Petroleum's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 30% 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. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Chennai Petroleum to turn into a multi-bagger.

On a side note, Chennai Petroleum's current liabilities have increased over the last five years to 65% 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. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Key Takeaway

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. It should come as no surprise then that the stock has fallen 67% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

On a separate note, we've found 1 warning sign for Chennai Petroleum you'll probably want to know about.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high 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.