Capital Allocation Trends At Kalyani Steels (NSE:KSL) Aren't Ideal

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Kalyani Steels (NSE:KSL) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

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 Kalyani Steels, this is the formula:

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

0.16 = ₹1.7b ÷ (₹15b - ₹3.9b) (Based on the trailing twelve months to December 2020).

Thus, Kalyani Steels has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 9.6% generated by the Metals and Mining industry.

Check out our latest analysis for Kalyani Steels

Historical performance is a great place to start when researching a stock so above you can see the gauge for Kalyani Steels' ROCE against it's prior returns. If you'd like to look at how Kalyani Steels has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From Kalyani Steels' ROCE Trend?

On the surface, the trend of ROCE at Kalyani Steels doesn't inspire confidence. To be more specific, ROCE has fallen from 23% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, Kalyani Steels has decreased its current liabilities to 27% of total assets. That could partly explain why the ROCE has dropped. 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.

Our Take On Kalyani Steels' ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Kalyani Steels have fallen, meanwhile the business is employing more capital than it was five years ago. Yet despite these poor fundamentals, the stock has gained a huge 117% over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

On a final note, we've found 1 warning sign for Kalyani Steels that we think you should be aware of.

While Kalyani Steels may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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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