Aditya Birla Fashion and Retail (NSE:ABFRL) Might Be Having Difficulty Using Its Capital Effectively

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Aditya Birla Fashion and Retail (NSE:ABFRL) and its ROCE trend, we weren't exactly thrilled.

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 Aditya Birla Fashion and Retail, this is the formula:

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

0.028 = ₹1.7b ÷ (₹112b - ₹48b) (Based on the trailing twelve months to December 2021).

Thus, Aditya Birla Fashion and Retail has an ROCE of 2.8%. Ultimately, that's a low return and it under-performs the Luxury industry average of 14%.

Check out our latest analysis for Aditya Birla Fashion and Retail

In the above chart we have measured Aditya Birla Fashion and Retail's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Aditya Birla Fashion and Retail here for free.

So How Is Aditya Birla Fashion and Retail's ROCE Trending?

Unfortunately, the trend isn't great with ROCE falling from 4.5% five years ago, while capital employed has grown 211%. Usually this isn't ideal, but given Aditya Birla Fashion and Retail conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Aditya Birla Fashion and Retail might not have received a full period of earnings contribution from it.

On a side note, Aditya Birla Fashion and Retail has done well to pay down its current liabilities to 43% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 43% is still pretty high, so those risks are still somewhat prevalent.

In Conclusion...

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Aditya Birla Fashion and Retail. Furthermore the stock has climbed 76% over the last five years, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.

While Aditya Birla Fashion and Retail doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.

While Aditya Birla Fashion and Retail 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. 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.