Seshasayee Paper and Boards (NSE:SESHAPAPER) may struggle to use capital efficiently

Finding a business that has the potential to grow significantly isn’t easy, but it is possible if we look at a few key financial metrics. A common approach is to try to find a company with Return on capital employed (ROCE) which is increasing, in line with growth amount capital employed. Simply put, these types of businesses are slot machines, meaning they continually reinvest their profits at ever-higher rates of return. That said, at a first glance at Seshasayee Paper and Cardboard (NSE:SESHAPAPER) we’re not jumping off our chairs on the yield trend, but taking a closer look.

What is return on capital employed (ROCE)?

For those unaware, ROCE is a measure of a company’s annual pre-tax profit (yield), relative to the capital employed in the business. Analysts use this formula to calculate it for Seshasayee Paper and Boards:

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

0.06 = ₹823m ÷ (₹16b – ₹2.1b) (Based on the last twelve months to December 2021).

So, Seshasayee Paper and Boards has a ROCE of 6.0%. Ultimately, that’s a poor return, and it’s below the forest industry average of 12%.

Check out our latest review for Seshasayee Paper and Boards

NSEI: SESHAPAPER Return on Capital Employed April 15, 2022

Although the past is not indicative of the future, it can be useful to know the historical performance of a company, which is why we have this graph above. If you want to further investigate the past of Seshasayee Paper and Boards, check out this free chart of past profits, revenue and cash flow.

What can we say about the ROCE trend of Seshasayee Paper and Boards?

When we looked at the ROCE trend at Seshasayee Paper and Boards, we didn’t gain much confidence. About five years ago, the return on capital was 20%, but since then it has fallen to 6.0%. Although, given that revenue and the amount of assets used in the business have increased, it could suggest that the business is investing in growth and that the additional capital has resulted in a short-term reduction in ROCE. And if the capital increase generates additional returns, the company, and therefore the shareholders, will benefit in the long term.

Incidentally, Seshasayee Paper and Boards did well to pay off its short-term debt at 13% of total assets. So we could tie some of that to the decline in ROCE. Additionally, it may reduce some aspects of risk to the business, as the business’s suppliers or short-term creditors now fund less of its operations. Some would argue that this reduces the company’s effectiveness in generating a return on investment, as it now finances more operations with its own money.

Seshasayee Paper and Boards ROCE Basics

Even though capital returns have fallen in the short term, we think it’s promising that both revenue and capital employed have increased for Seshasayee Paper and Boards. Moreover, the stock has climbed 49% in the last five years, it would seem that investors are optimistic about the future. So, while investors seem to be recognizing these promising trends, we would take a closer look at this stock to make sure the other metrics justify the positive view.

Seshasayee Paper and Boards have some risks, we noticed 3 warning signs (and 1 of concern) that we think you should know about.

Although Seshasayee Paper and Boards does not generate the highest yield, check out this free list of companies that achieve high returns on equity with strong balance sheets.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

About Nicole Harmon

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