FLSmidth (CPH:FLS) May Have Issues Allocating Its Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at FLSmidth (CPH:FLS) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for FLSmidth, this is the formula:

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

0.07 = kr.1.1b ÷ (kr.30b - kr.15b) (Based on the trailing twelve months to December 2022).

Therefore, FLSmidth has an ROCE of 7.0%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 11%.

Check out our latest analysis for FLSmidth

In the above chart we have measured FLSmidth'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 FLSmidth.

What Does the ROCE Trend For FLSmidth Tell Us?

When we looked at the ROCE trend at FLSmidth, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 7.0% from 9.8% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a separate but related note, it's important to know that FLSmidth has a current liabilities to total assets ratio of 49%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Key Takeaway

While returns have fallen for FLSmidth in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, despite the promising trends, the stock has fallen 34% over the last five years, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you'd like to know about the risks facing FLSmidth, we've discovered 1 warning sign that 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. 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.