Our Take On The Returns On Capital At China XLX Fertiliser (HKG:1866)

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look 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. 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.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on China XLX Fertiliser is:

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).

Therefore, China XLX Fertiliser has an ROCE of 5.9%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 9.9%.

View 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.

So How Is China XLX Fertiliser's ROCE Trending?

On the surface, the trend of ROCE at China XLX Fertiliser doesn't inspire confidence. To be more specific, ROCE has fallen from 9.4% over the last five years. 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.

On a side note, China XLX Fertiliser's current liabilities have increased over the last five years to 41% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 5.9%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Bottom Line On China XLX Fertiliser's ROCE

In summary, China XLX Fertiliser is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Although the market must be expecting these trends to improve because the stock has gained 86% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

If you'd like to know more about China XLX Fertiliser, we've spotted 4 warning signs, and 1 of them can't be ignored.

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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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