the-cap-ex-picture-looks-a-lot-like-late-cycle-behavior

The Cap-Ex Picture Looks A Lot Like Late Cycle Behavior

Investors would benefit from following companies and doing as corporations do: increase spending (buying stocks) when corporations do so, reduce spending (buying stocks) when corporations do so. In this article, I'll show why it pays to be cautious as companies are spending less and less on their own growth because they are less confident in the overall outlook of the economy.

There is an easy way to tell whether companies feel good about the state of the economy and that is to look at their capital expenditures. When economies have faith in the economy, they are more likely to increase spending, buy new tools, build new facilities, hire new people and grow their business. When they feel less comfortable with the economic environment, they often cut capital expenditures.

This can be a self feeding loop where companies feel good about the economy, they invest more into, then economy gets even better due to increased investments, or the opposite, where they feel bad about the economy, hold off on spending, then the economy goes worse due to lack of investment.

Last year, capital expenditures hit 25-year high and American companies collectively spent nearly $400 billion on capital expenditure; however, note that this is still a fraction of almost $1 trillion they spent on buybacks.

Since capital expenditures mostly reflect a company's investment into growth initiatives rather than ongoing operations, it is a valuable metric to track to see the size and direction of future growth in the economy. Also, looking at the total capital expenditures across many companies can give us a better idea about where the economy is headed.

Let's look at some of the most important companies in our economy to see how they are doing in 2019 in terms of spending for growth.

Industry giants are cutting down

In the chart below, you'll see capital expenditure trends for 6 American companies that produce big machinery. Whether you are producing commercial airplanes, tractors, bulldozers or family sedans, your business will be capital intensive as it involves millions of moving parts and managing massive supply chains. That's why it's important to look at how spending is trending in these companies. As you can see below, with the exception of John Deere (DE), our industry giants are cutting down on capital expenditures anywhere from 3% to 37% compared to 3 years ago.

ChartData by YCharts

Biotech industry is mixed

The biotech industry typically spends a lot of money no matter where we are in the business cycle because the survival of biotech companies depends on finding new drugs and bring them to the market before patents on their existing drugs expire. As you can see in the chart below, while some biotech companies have curbed capital spending by as much as 60% in the last 3 years, others are increasing their spend. Please note that the allocated capital expenditures can be spent on mergers and acquisitions and this type of activity is very common in this particular industry.

ChartData by YCharts

Consumer goods are curbing spending big time

Consumer goods is an industry that depends heavily on changing consumer tastes, and this is why these companies tend to be heavily diversified across many product types, brands and geographies in order to manage their risk. As you can see in the chart below, this entire industry has been cutting back on capital expenditures as they seem to expect the economy to come to a slow down. When companies like PG (PG) and Coca Cola (KO) cut their capital expenditures by as much as 30-40% in a 3 year period, this might very well be a sign that we are in the late market cycle.

ChartData by YCharts

Oil & energy is a mixed bag

When we look at the oil & energy sector, we see that some companies have been ramping up spending big time whole others were cutting back and holding off, hoping for a better time to invest their money since oil prices have been increasingly volatile in the last few years. Oil is a capital-intensive industry that requires constantly searching for new deserves, drilling, building new facilities to extract and process oil and distribute it to customers in an efficient manner. This is probably why this industry will always have at least some level of capital expenditure going on regardless of the state of the economy as long as oil prices are at least partially stable.

ChartData by YCharts

Technology

This is one industry where you can expect more and more capital spending year after year, and the industry's high growth and strong profit margins allow for such spending increases. Companies like Netflix (NFLX), Facebook (FB) and Alphabet (GOOG) have increased their capital spending by more than 100% in the last 3 years while Apple (AAPL) and Microsoft (MSFT) lagged behind. It's interesting to note that almost every tech company saw its cap-ex drop sharply in Q1 of 2019 as compared to Q4 of 2018 though. We'll have to wait and see if this drop was a temporary dip or a sign of something bigger that might be coming.

ChartData by YCharts

Retail

In retail, most capital spending comes from opening new stores, investing into supply chain improvements and increasing online presence. In the last three years, Home Depot, Target and Best Buy have been spending more than usual whereas Wal-Mart, Costco and Kroger have been more careful with their money. Even with this, when you look at the right end of the graph, you will notice that almost all retailers have been cutting down on capital expenditures since the end of 2018 but seasonality might be playing a role there. We'll see if this is the case once Q2 numbers start rolling in.

ChartData by YCharts

Conclusion

When companies feel confident in the outlook of the overall economy, they put their money to work and increase capital spending. This is what happened from 2009 to 2018 but now we are seeing mixed messages as more and more companies are either hoarding cash or spending their money on buying back stock rather than investing it into growth initiatives such as new plants, new supply chains and hiring new people. I'd urge investors to be careful with their money, pay attention to signs and keep a well diversified portfolio full of defensive positions. Keeping some money on the sidelines in case better opportunities come up wouldn't hurt either.

Disclosure: I am/we are long SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.