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Capex Caution

Bracing for a recession, many companies are reining in capital spending. But some say they must forge ahead.
Avital Louria Hahn, CFO Magazine
June 1, 2008

Capital spending generally goes as the economy goes — which means it's currently in the doldrums. Growth of U.S. capital expenditures (capex) has slowed from a robust 21 percent in 2006 to 13 percent in 2007 to nominal growth projected for 2008, according to business consultancy The Hackett Group. According to finance chiefs (both here and abroad) polled in Duke University/CFO magazine's latest Global Business Outlook survey, capital spending will rise a paltry 3 percent this year.

Company after company has announced that it will tighten the purse strings in 2008. For example, department store chain J.C. Penney will open fewer new stores, while specialty retailers from Ann Taylor to Zales are scaling back capex plans. Meanwhile, skyrocketing fuel prices have forced airlines like Delta and American to throttle back on capex, too.

JX Enterprises/Peterbilt of Wisconsin, a privately owned chain of truck dealerships that had planned to open one new dealership per year, has suspended its 2008 expansion, says CFO Mark Muskevitsch. "Last year we had an aggressive capital-spending plan," he says. "So far this year we have done only things we have to do, such as replacing computer hardware, but not facility upgrades or refinishing lots." Computer-software upgrades will have to wait until sales pick up, he adds.

Still, says Muskevitsch, trucking demand usually begins to recover before other sectors, which means business may pick up in the second half of the year. If so, the company will consider a modified expansion plan — leasing rather than buying a new facility.

Power Spenders
To a large extent capex strategies depend on what industry you play in. Companies in some sectors, such as biotechnology and telecommunications, still have solid growth prospects and have to invest, points out Roger Wery, director of the operational strategy practice at consulting firm PRTM. "Some companies can't stop investing, because they are in a ruthless, competitive environment," he adds. Yahoo, for example, is spending large amounts on capex even though its EBITDA (earnings before interest, taxes, depreciation, and amortization) has slowed. "They feel pinched, but they have to continue to invest," says Wery.

Companies in the energy and utility sectors have been more fortunate, ramping up their capital budgets as their earnings soar. For example, ExxonMobil is spending 20 percent more on capex in 2008 (up to $25 billion), while Duke Energy, seeking to match the high demand for electricity (and concomitant rising prices), remains committed to a five-year, $23 billion capital plan to improve its power plants and build new generation capacity. While the number of "new hookups," or customers, is slowing, usage by existing customers is rising, says Duke Energy CFO David Hauser, adding that demand is expected to exceed supply for some time.

Energy, of course, faces a unique set of challenges and opportunities that make it difficult to scale back capex as a short-term fix in troubled times. PPL Corp., which generates electricity from coal, gas, nuclear, and hydroelectric power, will devote part of its $1.6 billion capex budget this year to renewable-energy projects and compliance with pollution regulation. "The dynamic in our sector is that between regulatory pull and market pull," says CFO Paul Farr. PPL spent $1.7 billion on capex in 2007, when it paid for giant scrubbers to remove sulfur and other pollutants from the utility's coal-generating plants. Even as it copes with environmental issues, it is also considering building a new nuclear plant, which would be a multiyear, multibillion-dollar project. The math just might work, says Farr. "When we look at the energy marketplace, the price and the demand for electricity, it's very compelling to spend the capital and live through those long construction cycles."

That's not to say that CFOs like Hauser and Farr aren't worried about the credit crunch. Hauser says he tapped the capital markets in March, earlier than needed, in order to build a safety cushion for Duke. He also increased the company's credit facility from $2.6 billion to $3.4 billion. Similarly, PPL, which finances half of its projects with surplus cash and the rest with debt and hybrid securities, expanded a bilateral credit facility.

In other sectors, even direct competitors may take markedly different approaches to capex. Amid a housing slump and beset by other woes, Home Depot has scaled back its expansion plans for the near future and will open 55 new stores in 2008, while rival Lowe's is sticking to its original intention to open 120 new locations. The shares of both companies rose in response to their decisions.

Decapitalizing
Other companies are cutting back on capital spending by eliminating the need for it, via outsourcing. After all, the more factories and facilities a company has, the heavier the burden of keeping them busy during a downturn.

This has been a particular challenge in the semiconductor sector, which has been struggling with production overcapacity and falling prices. The sector is projected to show flat to slight growth in 2008, but its capital equipment spending is expected to drop 20 percent, according to Gartner. In part, that's because many semiconductor companies have been going "fabless," outsourcing the actual fabrication of their chips to giant foundries such as Taiwan Semiconductor Manufacturing Co. and United Microelectronics Corp.


Cypress Semiconductor, for example, adopted a "fab-lite" model last year, outsourcing nearly half of its production. Accordingly, it slashed its capital budget by half, from more than $100 million in 2006 to $50 million in both 2007 and 2008. For chip companies, "the lighter the capital, the more profitable," comments PRTM's Wery.

Indeed, when it comes to capital intensity, less is more for most companies, adds Wery. While there are exceptions, most companies can choose an operational model that requires less capital spending, he says. Such a model especially pays off during a downturn. "The more 'decapitalized' you are, the better off you are," says Wery.

Avital Louria Hahn is a senior editor at CFO.


Controlled Spending
Five ways to manage capex in a slowdown

Align your capital strategy with your business strategy — not just during a recession, but all the time, says Roger Wery, director of the operational strategy practice at PRTM. "Don't be distracted by the short term."

Buy computer software right before a fiscal quarter's end, advises Brad Buss, CFO of Cypress Semiconductor. Vendors will be trying to make their numbers and will be more likely to give discounts.

Keep a "capital book" and review it frequently, says Buss. Is an expense still justified? Have the assumptions that led to it changed? Cypress checks its book every Friday. "It takes us exactly 20 minutes to look at it," he says.

Conduct a vigorous analysis of the results of capital spending, both Buss and Wery advise. Knowing your ROI is a must.

Outsource as much as you can and keep your capital budget as lean as possible. That will help you weather downturns better, since you won't have to keep factories humming. — A.L.H.




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