Will The ROCE Trend At National Fertilizers (NSE:NFL) Continue?

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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So on that note, National Fertilizers (NSE:NFL) looks quite promising in regards to its trends of return on capital.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on National Fertilizers is:

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

0.14 = ₹7.1b ÷ (₹126b - ₹74b) (Based on the trailing twelve months to December 2020).

Thus, National Fertilizers has an ROCE of 14%. That's a relatively normal return on capital, and it's around the 15% generated by the Chemicals industry.

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'd like to look at how National Fertilizers has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

National Fertilizers has not disappointed with their ROCE growth. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 187% in that same time. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 59% of its operations, which isn't ideal. And with current liabilities at those levels, that's pretty high.

In Conclusion...

As discussed above, National Fertilizers appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

If you want to know some of the risks facing National Fertilizers we've found 4 warning signs (2 are significant!) that you should be aware of before investing here.

While National Fertilizers 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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