See the capital-spending scorecard
It's no secret that the economy's anemic recovery from the recent recession reflects weak spending on the part of corporations. While the Federal Reserve Board has kept interest rates low to keep borrowing costs down, the confidence of consumers — whose spending represents some two-thirds of gross domestic product — has been dampened by weak job growth. And the lackluster trend in employment reflects companies' reluctance to open their wallets.
Instead of making new investments, most companies seem content to allow cash to pile up on their balance sheets (see "Too Much Cash," August).
When will capital spending pick up again? Some observers say it will be sooner rather than later. After all, the Fed reported a rebound in corporate spending for the second quarter, ending June 30. Capital expenditures of nonfarm, nonfinancial corporations rose to an annualized rate of $892 billion, up 21 percent from a post-2000 low of $737 billion in 2002. The latest figures are only 4 percent below the $929 billion that those companies spent in 2000.
Monthly durable-goods orders, a leading indicator of capital spending, rose for the third month in four last September (after taking out orders for both defense and transportation equipment). And in some industries — including energy and utilities, health care, food and beverages, and aerospace and defense — capital spending increased by an average annual rate of 6 percent or more from 2000 through 2003, according to a new study by Pittiglio Rabin Todd & McGrath (PRTM), a Waltham, Massachusetts-based management-consulting firm.
But other observers question whether such data presages a broad-based revival of capital spending, given the economy's weak fundamentals. "The rate of growth of profits, industrial production, and job creation is slowing," notes Philip Arestis of the Cambridge Centre for Economic and Public Policy at the University of Cambridge, in England. While consumers' spending continues to grow, their incomes are rising less rapidly, calling into question the sustainability of their purchasing power.
Meanwhile, PRTM's new study of spending at 300 companies — presented here as CFO's first capital-spending scorecard — shows just how deep, and wide, the capital-spending trough has been. During the past four years, the 20 largest U.S. and foreign companies in 15 capital-intensive industries reduced their expenditures by 17.9 percent. The total for the companies in the study came to $533 billion in 2003, compared with $649 billion in 2000. And the decline in spending came despite a 9 percent increase in revenue for the group during the same period. Unless these companies are about to abruptly reverse course — and there's little evidence beyond the latest durable-goods report to suggest they will — it seems clear that the U.S. and global economies will continue to be held back in the near term by weak expenditures.
Yet the study also gives reason for optimism. By tracking the top performers in capital spending as measured by return on gross fixed assets (see "Measuring Capex," at the end of this article), our scorecard shows that companies can spend more on capex without hurting their bottom lines.
Spending on Innovation
Of course, some industries, including chemicals and heavy manufacturing, are particularly cyclical and therefore face troughs and peaks in capital spending. Others, including pharmaceuticals and technology, have to keep spending to maintain technological progress. Yet Amram Shapiro, director of PRTM, insists that capital spending that supports innovation is critical to both types.
"In long-product-life-cycle, capital-intensive industries, where plant capacity is often added at a large scale, whether best-in-class process technology is developed and piloted and ready to scale up determines the economics of the company for many years," explains Shapiro. "In short-product-life-cycle, R&D-intensive industries, the ability to execute quickly and ramp up to the levels needed is often the secret to success."
Corning Inc., which has spent the past several years writing down huge investments in fiber-optic technology, now plans to spend $900 million to $1 billion in 2005, mostly on new plants that make liquid crystal display (LCD) screens for flat-panel computer monitors. That figure is two-and-a-half times what it spent in 2004. "We are ramping up our capital spending quite significantly," says Jim Flaws, CFO of the Corning, New York-based diversified technology company. Flaws points out that Corning isn't betting on a broad economic recovery to justify its new spending, but rather is seeking to exploit a specific growth opportunity.
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