FLSmidth (CPH:FLS) Has Some Difficulty Using Its Capital Effectively

June 03, 2022
  •  Updated
September 07, 2022
CPSE:FLS
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When researching a stock for investment, what can tell us that the company is in decline? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. Having said that, after a brief look, FLSmidth (CPH:FLS) we aren't filled with optimism, but let's investigate further.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for FLSmidth:

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

0.071 = kr.943m ÷ (kr.24b - kr.11b) (Based on the trailing twelve months to March 2022).

Thus, FLSmidth has an ROCE of 7.1%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 10%.

Check out our latest analysis for FLSmidth

roce
CPSE:FLS Return on Capital Employed June 3rd 2022

Above you can see how the current ROCE for FLSmidth compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From FLSmidth's ROCE Trend?

We are a bit worried about the trend of returns on capital at FLSmidth. To be more specific, the ROCE was 8.9% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on FLSmidth becoming one if things continue as they have.

On a separate but related note, it's important to know that FLSmidth has a current liabilities to total assets ratio of 44%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

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. Long term shareholders who've owned the stock over the last five years have experienced a 44% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

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

While FLSmidth may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

Valuation is complex, but we're helping make it simple.

Find out whether FLSmidth is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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