VideoIf consumers spent like companies, credit-card debt would vanish. When it comes to capital spending, recent data suggests that CFOs on the whole are scaling back their expectations (see By the Numbers). And while those employed in the 15 most capital-intensive U.S. industries have relaxed their grips on their checkbooks, caution remains the watchword. (See the 2006 Capital Spending Scorecard.)
For the three-year period from 2002–2005, reports management consulting firm PRTM, all but one of those industries increased capital spending, up from only 6 of 15 in the period 2001–2004. Not surprisingly, the energy and petrochemicals industry, riding what until recently had been a remarkable run-up in energy prices, has been the biggest spender by sheer dollar volume. The 20 largest companies in that sector shelled out an average $3.5 billion each in capital expenditure (capex) in 2005, equal to 12 percent of their revenues. Only the communication-services industry was more capital intensive, channeling 15 percent of revenue to capex, or an average of $2.4 billion per company among the industry's 20 biggest players. Metals and chemicals companies couldn't match those raw dollar figures, but they did ramp up their spending faster than anybody else over the latest three-year period, with compound annual capex growth rates of 28 percent and 20 percent, respectively.
While there were strong differences by industry, one common theme emerged: increases to capex spending lagged increases in revenue among North America's 300 largest companies virtually across the board. Revenue grew at a 12.8 percent compound annual rate from 2002 to 2005, while capex grew only 5.1 percent. That suggests both a healthy capex outlook and, according to PRTM's director of operational strategy practice, Roger Wery, room for further increases. "The picture today is not completely perfect," Wery concedes, citing the slumping housing market and volatile energy prices, "and certainly every industry has a different pulse and cycle. But when you look at all the curves together, it's a sustained and smooth trend that we would expect to continue for at least two years."
As for why capex has not moved in lockstep with revenue growth, Wery suggests that the reasons vary by company. "Assuming the revenue growth correlates with increased profits," he says, "companies may favor other uses for their increased cash flow: to buy back shares, pay dividends, add to their cash reserves, or pull whatever other operational lever suits their needs at the time." In short, he says, although there is a long-term relationship between revenue growth and increased capex spending, many other factors explain annual variances.
In Search of Bigger Payoffs
What matters to most companies, however, isn't how much they spend but how well they spend. To identify those that are most adroit at balancing capital spending with customer demand, PRTM ranks the 20 largest companies in 15 capital-intensive industries by a measure it calls adjusted return on gross fixed assets, or ROGFA, which roughly equates to the ratio of operating profits to capital spending. (For more on the methodology, see "Measuring Capex" at the end of this article.) In many industries, a high ROGFA correlates with strong performance in other key areas, such as sales growth and shareholder return.
Case in point: $2.3 billion SanDisk Corp., a Milpitas, California-based producer of flash memory cards and related products used in digital cameras, mobile phones, MP3 music players, networking equipment, and other electronic devices. Demand for such gear is soaring, and SanDisk, whose revenues have more than doubled in the past three years, has been investing furiously to keep pace. For the most-recent three-year period tracked by PRTM, it increased capex at a compound annual rate of 101 percent, shelling out $134 million in 2005. That compared with an average 17 percent capex growth rate for North America's 20 largest semiconductor companies. More important, SanDisk posted a ROGFA of 219 percent in 2005, and a compound annual return of 84 percent for shareholders over the three-year period ending in 2005. Both were tops in its sector.
Judy Bruner, SanDisk's CFO and executive vice president for administration, says the company's capex last year actually exceeded the $134 million captured on its cash-flow statement because that figure did not include investments in joint ventures. Those ventures, however, contribute substantially to SanDisk's strong returns on its investments, and illustrate how even a company in the midst of a boom is being careful with its capex outlays.
"Our long-term model is to own about 70 percent of our memory, in terms of captive supply, and to purchase about 30 percent from third parties," Bruner says. "By doing that, we significantly mitigate any downside risk if market demand is not as strong as anticipated, because we can pull back on the noncaptive purchases."
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