This analysis is intended to introduce important early concepts to people who are starting to invest and want a simplistic look at the return on CF Industries Holdings Inc (NYSE:CF) stock.
If you purchase a CF share you are effectively becoming a partner with many other shareholders. Your equity share is granted in return for the capital provided to the business to operate, and in order for an investment to be successful the business has to create earnings from the funds that make up this capital. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. To understand CF Industries Holdings’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.
Check out our latest analysis for CF Industries Holdings
Calculating Return On Capital Employed for CF
When you choose to invest in a company, there is an opportunity cost because that money could’ve been invested elsewhere. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. To determine CF Industries Holdings’s capital return we will use ROCE, which tells us how much the company makes from the capital employed in their operations (for things like machinery, wages etc). Take a look at the formula box beneath:
ROCE Calculation for CF
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$249m ÷ (US$13.0b – US$482m) = 2.0%
As you can see, CF earned $2 from every $100 you invested over the previous twelve months. This makes CF Industries Holdings disappointing when compared to a robust 15% ROCE yardstick. So if this rate continues in to the future, investor capital may be able to compound over time, but not to standard that investors should be aiming for.
Why is this the case?
CF Industries Holdings’s relatively poor ROCE is tied to the movement in two factors that change over time: earnings and capital requirements. At the moment CF Industries Holdings is in an adverse position, but this can change if these factors improve. Because of this, it is important to look beyond the final value of CF’s ROCE and understand what is happening to the individual components. Looking at the past 3 year period shows us that CF weakened investor return on capital employed from 15%. With this, the current earnings of US$249m actually declined from US$1.5b whilst capital employed has increased due to an increase in total assets and a smaller reliance on current liabilities (less borrowing to fund operations) , which means the company’s ROCE has shrunk as a result of falling earnings and simultaneous increases in capital requirements.
Next Steps
CF’s investors have experienced a downward trend in ROCE and it is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. But don’t forget, return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like future prospects and valuation. If you’re building your portfolio and want to take a deeper look, I’ve added a few links below that will help you further evaluate CF or move on to other alternatives.
- Future Outlook: What are well-informed industry analysts predicting for CF’s future growth? Take a look at our free research report of analyst consensus for CF’s outlook.
- Valuation: What is CF worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether CF is currently undervalued by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.