Australia markets open in 1 hour 20 minutes
  • ALL ORDS

    7,114.50
    -133.60 (-1.84%)
     
  • AUD/USD

    0.7033
    -0.0087 (-1.22%)
     
  • ASX 200

    6,838.30
    -123.30 (-1.77%)
     
  • OIL

    87.14
    -0.21 (-0.24%)
     
  • GOLD

    1,795.40
    -34.30 (-1.87%)
     
  • BTC-AUD

    50,894.87
    -1,630.48 (-3.10%)
     
  • CMC Crypto 200

    810.76
    -8.74 (-1.07%)
     

Here's What's Concerning About a2 Milk's (NZSE:ATM) Returns On Capital

  • Oops!
    Something went wrong.
    Please try again later.
  • Oops!
    Something went wrong.
    Please try again later.
·3-min read
In this article:
  • Oops!
    Something went wrong.
    Please try again later.
  • Oops!
    Something went wrong.
    Please try again later.
  • ACOPF
  • ACOPY

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think a2 Milk (NZSE:ATM) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What is it?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for a2 Milk, this is the formula:

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

0.12 = NZ$126m ÷ (NZ$1.4b - NZ$275m) (Based on the trailing twelve months to June 2021).

So, a2 Milk has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Food industry average of 8.4% it's much better.

See our latest analysis for a2 Milk

roce
roce

Above you can see how the current ROCE for a2 Milk compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for a2 Milk.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at a2 Milk, we didn't gain much confidence. Around five years ago the returns on capital were 40%, but since then they've fallen to 12%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, a2 Milk has done well to pay down its current liabilities to 20% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From a2 Milk's ROCE

In summary, we're somewhat concerned by a2 Milk's diminishing returns on increasing amounts of capital. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 213%. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

One more thing to note, we've identified 1 warning sign with a2 Milk and understanding it should be part of your investment process.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

Our goal is to create a safe and engaging place for users to connect over interests and passions. In order to improve our community experience, we are temporarily suspending article commenting