Capital Allocation Trends At National Fertilizers (NSE:NFL) Aren't Ideal

What financial metrics can indicate to us that a company is maturing or even in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. On that note, looking into National Fertilizers (NSE:NFL), we weren't too upbeat about how things were going.

What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for National Fertilizers, this is the formula:

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

0.084 = ₹4.3b ÷ (₹125b - ₹74b) (Based on the trailing twelve months to June 2023).

Thus, National Fertilizers has an ROCE of 8.4%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 14%.

See our latest analysis for National Fertilizers

Historical performance is a great place to start when researching a stock so above you can see the gauge for National Fertilizers' ROCE against it's prior returns. If you're interested in investigating National Fertilizers' past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

We are a bit worried about the trend of returns on capital at National Fertilizers. To be more specific, the ROCE was 14% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on National Fertilizers becoming one if things continue as they have.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 59%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 8.4%. 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

In summary, it's unfortunate that National Fertilizers is generating lower returns from the same amount of capital. Since the stock has skyrocketed 176% over the last five years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

If you want to know some of the risks facing National Fertilizers we've found 2 warning signs (1 shouldn't be ignored!) that you should be aware of before investing here.

While National Fertilizers 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.