Global Economy
Recovery in global corporate capex some way off - Part 2
By Michael Hennigan, Finfacts founder and editor
Aug 18, 2014 - 5:37 AM

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A recovery in the global corporate capital expenditure (capex) cycle is some way off, according to a June 2014 report published by Standard&Poor's Ratings Services. Despite healthy corporate balance sheets, global capex spending fell by 1% in real terms in 2013. Current estimates suggest a similar decline is likely in 2014 and early indications for 2015 are even more pessimistic.

This 2014 estimate, based on first half data, means global capex will be stuck at the $3.3tn mark for the third consecutive year, with no growth in sight. "A recovery in capex remains one of the most keenly anticipated trends in the global economy," said Gareth Williams, corporate sector economist at Standard & Poor's in London.

The forecast tracks 2,000 global companies that had gross cash of $4.5tn in 2013.

Aggressive cuts to capital expenditure are being implemented by metals and mining  companies. The analysis suggests that the downward pressure here will be sustained for the next few years and risks spreading to the oil and gas sector where a decade-long capex boom is running out of cashflow headroom. "This has huge significance for the capex outlook given that these industries together accounted for 42% of global corporate capex in 2013."

S&P said that emerging market capex is showing a case of serious indigestion. Spending fell by 4% in real terms in 2013 and looks set for a similar decline in 2014. The decline is broad-based and has affected corporates in Brazil, Russia, India and, surprisingly, China.

This marks the first significant reversal in the long-term uptrend since the various emerging market crises of the 1990s and leaves global capex growth reliant for now on slow-growing developed markets.

S&P says expected cutbacks in European spending from key companies like Royal Dutch Shell and Total imply a negative contribution from energy in 2014. Better news comes from autos and telecoms, including Volkswagen, Daimler and Vodafone. Even so, overall growth is likely to be a mere 1% in real terms in 2014.

Michael J. Mauboussin and Dan Callahan at Credit Suisse said this month that while US companies are failing to invest in the future, R&D (research and development) spending has remained strong while capital expenditures although lower than during the 1980s and 1990s, in 2013 reached the highest levels since 2001.

The analysts say:

"In the past 30 years, capital expenditures are down, and R&D is up, as a percentage of sales. This reflects a shift in the underlying US economy. M&A is the largest use of capital but follows the stock market closely. More deals happen when the stock market is up.

Capital expenditures went from roughly 10% of sales to approximately 6% over the period 1980-2013. "The simplest explanation is that the composition of the economy has changed, with businesses that require less capital investment replacing those that require more. For example, the energy, materials, and industrial sectors represented 50% of the market capitalization of the top 1,500 companies in the U.S. market in 1980 but just 25% in 2013. During the same time, the healthcare and technology sectors went from 17 to 30% of the market capitalization. This shift also helps explain the increase in cash holdings.11 Another possible cause of the dip in capital expenditures is that public companies are now investing too little. Academic research suggests that public companies invest less than comparable private companies because they want to maximize short-term earnings."

The amount companies have spent on buybacks has exceeded dividends for the past decade, except for 2009. Buybacks did not become relevant in the U.S. until 1982, so you should treat comparisons of yields before and after 1982 with caution. Research shows that the overall proclivity to return cash has not changed much over the decades, but the means by which the payout occurs has shifted.

Academic research shows that rapid asset growth is associated with poor total shareholder returns. Further, companies that contract their assets often create substantial value per share. Ultimately, the answer to all capital allocation questions is, 'It depends.' Most actions are either foolish or smart based on the price and value.

Internal financing represented almost 90% of the source of total capital for US companies from 1980-2013. This is a higher percentage than that of other developed countries including the United Kingdom, Germany, France, and Japan."

Morgan Stanley analysts said in July:

"It's clear that persistently weak investment in the aftermath of the recession has had a serious impact on normal capital deepening and dragged down productivity. While we can reasonably expect investment levels to fall after a recession, we have seen a period of persistent weakness in business investment in equipment that has impaired the economy's trend growth potential as it continued year after year.

Waiting for business investment to accelerate has been a painful and thankless exercise. Yet we find the necessary ingredients are present for capex to pick up. What's sobering is that even among these emerging positive signs, a lower rate of potential growth in the economy likely implies a lower rate of equilibrium investment levels. That means that even as the headwinds from factors such as increased M&A activity lift, our expectation for a modest cyclical upturn in investment may indeed by as good as it gets. A more historically normal cyclical pickup, something in excess of 8% annually, simply looks unrealistic.

Capex: Average age of US industrial equipment at highest since 1938 - Part 1
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