China XLX Fertiliser (HKG:1866) Is Looking To Continue Growing Its Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. So when we looked at China XLX Fertiliser (HKG:1866) and its trend of ROCE, we really liked what we saw.

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. To calculate this metric for China XLX Fertiliser, this is the formula:

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

0.15 = CN¥1.9b ÷ (CN¥23b - CN¥11b) (Based on the trailing twelve months to June 2021).

Thus, China XLX Fertiliser has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 12% it's much better.

See our latest analysis for China XLX Fertiliser

Above you can see how the current ROCE for China XLX Fertiliser 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 China XLX Fertiliser here for free.

How Are Returns Trending?

The trends we've noticed at China XLX Fertiliser are quite reassuring. The data shows that returns on capital have increased substantially over the last five years to 15%. Basically the business is earning more per dollar of capital invested and in addition to that, 58% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 46% of its operations, which isn't ideal. And with current liabilities at those levels, that's pretty high.

The Bottom Line On China XLX Fertiliser's ROCE

To sum it up, China XLX Fertiliser has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And a remarkable 224% total return over the last five years tells us that investors are expecting more good things to come in the future. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

One more thing, we've spotted 2 warning signs facing China XLX Fertiliser that you might find interesting.

While China XLX Fertiliser isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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