Is China XLX Fertiliser (HKG:1866) Likely To Turn Things Around?

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Having said that, from a first glance at China XLX Fertiliser (HKG:1866) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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)

0.059 = CN¥667m ÷ (CN¥19b - CN¥7.9b) (Based on the trailing twelve months to June 2020).

So, China XLX Fertiliser has an ROCE of 5.9%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 11%.

See our latest analysis for China XLX Fertiliser

In the above chart we have measured China XLX Fertiliser'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 China XLX Fertiliser.

What Does the ROCE Trend For China XLX Fertiliser Tell Us?

On the surface, the trend of ROCE at China XLX Fertiliser doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.9% from 9.4% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 41%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

What We Can Learn From China XLX Fertiliser's ROCE

To conclude, we've found that China XLX Fertiliser is reinvesting in the business, but returns have been falling. Unsurprisingly, the stock has only gained 3.9% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

China XLX Fertiliser does have some risks, we noticed 3 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

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.

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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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