Hexcel Corporation (NYSE:HXL) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

Hexcel (NYSE:HXL) has had a great run on the share market with its stock up by a significant 7.1% over the last month. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to Hexcel's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Hexcel

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Hexcel is:

6.8% = US$108m ÷ US$1.6b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.07 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Hexcel's Earnings Growth And 6.8% ROE

At first glance, Hexcel's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 12%. Given the circumstances, the significant decline in net income by 15% seen by Hexcel over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.

However, when we compared Hexcel's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 8.9% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is HXL fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Hexcel Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 25% (where it is retaining 75% of its profits), Hexcel has seen a decline in earnings as we saw above. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.

Additionally, Hexcel has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 26%. However, Hexcel's ROE is predicted to rise to 13% despite there being no anticipated change in its payout ratio.

Summary

In total, we're a bit ambivalent about Hexcel's performance. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.