Should You Be Impressed By Luxchem Corporation Berhad's (KLSE:LUXCHEM) Returns on Capital?

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. Although, when we looked at Luxchem Corporation Berhad (KLSE:LUXCHEM), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What is it?

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 Luxchem Corporation Berhad:

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

0.18 = RM58m ÷ (RM420m - RM95m) (Based on the trailing twelve months to September 2020).

Thus, Luxchem Corporation Berhad has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 6.3% generated by the Trade Distributors industry.

Check out our latest analysis for Luxchem Corporation Berhad

In the above chart we have measured Luxchem Corporation Berhad's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Luxchem Corporation Berhad.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Luxchem Corporation Berhad doesn't inspire confidence. Around five years ago the returns on capital were 23%, but since then they've fallen to 18%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Luxchem Corporation Berhad has done well to pay down its current liabilities to 23% of total assets. That could partly explain why the ROCE has dropped. 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.

What We Can Learn From Luxchem Corporation Berhad's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Luxchem Corporation Berhad have fallen, meanwhile the business is employing more capital than it was five years ago. Yet despite these concerning fundamentals, the stock has performed strongly with a 79% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

On a final note, we've found 1 warning sign for Luxchem Corporation Berhad that we think you should be aware of.

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This article by Simply Wall St is general in nature. 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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