We Like These Underlying Trends At Reliance Power (NSE:RPOWER)

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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings back into the business at ever-higher rates of return. With that in mind, we've noticed some promising trends at Reliance Power (NSE:RPOWER) so let's look a bit deeper.

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 Reliance Power is:

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

0.069 = ₹26b ÷ (₹533b - ₹160b) (Based on the trailing twelve months to March 2020).

Thus, Reliance Power has an ROCE of 6.9%. Even though it's in line with the industry average of 7.1%, it's still a low return by itself.

View our latest analysis for Reliance Power

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 Reliance Power's past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Reliance Power Tell Us?

Reliance Power has not disappointed in regards to ROCE growth. The data shows that returns on capital have increased by 73% over the trailing five years. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. In regards to capital employed, Reliance Power appears to been achieving more with less, since the business is using 28% less capital to run its operation. If this trend continues, the business might be getting more efficient but it's shrinking in terms of total assets.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 30% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

In Conclusion...

From what we've seen above, Reliance Power has managed to increase it's returns on capital all the while reducing it's capital base. However the stock is down a substantial 91% in the last five years so there could be other areas of the business hurting its prospects. Regardless, we think the underlying fundamentals warrant this stock for further investigation.

On a final note, we found 3 warning signs for Reliance Power (2 don't sit too well with us) you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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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