To be sure, the restaurant division itself was performing dismally. With operating cash flow growth trailing net income by almost 4,000 percent, Tricon Global Restaurants, as the division is now known, ranked fourth in the S&P's Compustat study. Yet PepsiCo's own performance hasn't been anything to write home about, with operating cash flow growth trailing net income growth by 82 percent.
In fact, restructuring moves shrank PepsiCo's revenue growth by about 11 percent from 1995 to 1999, according to CFO Indra Nooyi. And while that has improved the company's return on invested capital by 5 percentage points, she concedes that "it's the easiest thing in the world to shrink a company." She notes, however, that operating cash flow has also increased from $1.4 billion to $2 billion, and that its growth will accelerate in the near future as other moves, including the acquisition of Tropicana last year, produce more profitable top-line growth. Nooyi says PepsiCo's entire focus since 1995 has been on maintaining a "quality earnings-growth rate in a capital-efficient way."
The key, she says, is to have a "maniacal" focus on innovation, which she says PepsiCo now works hard to maintain. "We don't want to run out of good ideas in two or three years," she says, adding that such a failure would leave the company "dependent on one-time charges or taking costs out of the system."
Of course, as Nooyi points out, since operating cash flow lags new expenditures on growth initiatives, comparing it against net income in any given year can be misleading--what she calls "a tailpipe indicator." And despite its relative purity as a measure, operating cash flow can still be distorted by nonoperating items, including, for instance, the generous accounting treatment of the tax benefits of stock options. Here practices vary widely. Microsoft (#51), for one, includes such benefits in cash flow from financing activities, as opposed to operations. But Lucent Technologies Inc. does the opposite, which provides a nonoperating boost to its operating cash flow. (Lucent did not have the requisite 12 quarters' worth of reported data to qualify for the S&P's Compustat study.)
Capital Exceptions
By the same token, some analysts contend that focusing on cash flow from operations penalizes profitable and fast-growing but capital-intensive businesses. "Many companies with decent profitability will chew up cash if they're growing by 25 to 30 percent," says Bruce Hyman, a credit analyst for Standard & Poor's. On the other hand, says Hyman, "they'll throw off cash if growth is slow."
Hence the huge gap between net income growth and operating cash flow at companies like Texas Instruments. Following a series of divestitures and acquisitions that have repositioned TI in faster-growing markets, the company doubled its capital spending last year to take advantage of growing demand. If anything, it had underinvested previously, according to CFO Aylesworth: "In hindsight, we wished we had spent even more, because now we're up against some capacity shortages." But because of TI's spending, he says, there's been a lag between cash flow from operations and net income. "TI's gone through a very considerable transition in the last four years," he notes. "Our performance during that time hasn't been as consistent as we think it will be in the future." Nevertheless, he is committed to strong capital investment, calling it "the lifeblood of the company."
But why does TI eschew an obvious alternative--outsourcing its manufacturing operations? Many high-tech companies have done just that, leaving everything but chip design to contract manufacturers. Aylesworth responds that TI prefers to do its own manufacturing because it gives the company more control over the quality and supply of its products, and because the "synergies we get from integrating process technology with product technology provide enhancements in our return on capital." The CFO says TI's competitors that outsource "are companies that don't have the capital to invest in billion-dollar wafer fabs."
In fact, the S&P's Compustat study suggests that outsourcing one's manufacturing may not be the panacea that some think it is. One chipmaker renowned for the practice, Xilinx, ranks high (#14) on the list. While CFO Kris Chellam stands by his company's practice of outsourcing as "the best use of our capital," that hasn't eliminated the need for significant expenditures. In fact, Xilinx recently saw fit to retool a testing facility in Ireland to help sustain its growth, allowing Xilinx to test lower-cost versions of its programmable logic chips.
But with testing typically accounting for 10 percent of Xilinx's production costs, the expenditures on the Dublin plant have caused Xilinx's overhead expense to rise from 29 percent of revenue to 35 percent. Meanwhile, notes Chellam, net income has been boosted from items not reflected in Xilinx's operating cash flow, including options-related tax benefits and investment gains on sales of equity interests in two key contract manufacturers.
Others besides TI, Xilinx, and PepsiCo are counting on such strategic changes to yield significant improvement. While heavy capital outlays have cut into Ryder's cash flow from operations, the company has recently realigned its incentive system to favor marketing and sales of higher-margin services. "We're no longer rewarding people for unprofitable sales," says CFO Nelson.
Reader Comments» Post a comment