Neogen Chemicals' (NSE:NEOGEN) Returns On Capital Not Reflecting Well On The Business

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Neogen Chemicals (NSE:NEOGEN) and its ROCE trend, we weren't exactly thrilled.

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. To calculate this metric for Neogen Chemicals, this is the formula:

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

0.19 = ₹593m ÷ (₹4.9b - ₹1.7b) (Based on the trailing twelve months to June 2021).

Therefore, Neogen Chemicals has an ROCE of 19%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Chemicals industry average of 17%.

View our latest analysis for Neogen Chemicals

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

So How Is Neogen Chemicals' ROCE Trending?

When we looked at the ROCE trend at Neogen Chemicals, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 19% from 41% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Neogen Chemicals has done well to pay down its current liabilities to 35% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

Our Take On Neogen Chemicals' ROCE

To conclude, we've found that Neogen Chemicals is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 104% return in the last year, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

On a final note, we've found 2 warning signs for Neogen Chemicals that we think you should be aware of.

While Neogen Chemicals 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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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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