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Cutbacks in capital spending have made corporate free cash flow stronger than ever, says a new study.
Sarah Johnson, CFO.com | US
April 29, 2010
Like children of the Great Depression who stuffed cash under their mattresses as adults, many companies have taken the lessons learned during the liquidity scares of late 2008 to heart. They have become cash hoarders after watching traditional short-term borrowing methods dry up or become cost-prohibitive. And they have held back on making capital expenditures while waiting for clear signals that the economy is making a full recovery.
As a result, despite the recession and falling revenues, companies have continued to maintain strong free cash flow. In fact, researchers at the Georgia Tech Financial Analysis Lab report that companies' free cash margins — free cash flow measured as a percentage of revenue — stood at 6.56% at the end of the fourth quarter of 2009. That's the highest level since the lab began tracking the metric in 2000, surpassing the previous high of 5.36% in September 2009.
"Companies have gotten really good at wringing out as much free cash flow as they can from flat or declining revenue," says Charles Mulford, director of the lab and co-author of the ongoing cash-flow study, which tracks the trailing 12-month performance of companies with market caps of $50 million or more (3,786 in the latest sample). They have squeezed out cash through what Mulford calls the "usual suspects": improving gross margins, lowering SG&A costs, and managing working capital.
"Just like a family that wants to be extremely frugal with their budget during the recession and find ways to conserve cash, companies have done the same thing," says Mulford.
But sooner or later, companies that want to grow will have to loosen the purse strings on capital spending, which has been on the decline for the past two years. "At some point, you have to replace fixed assets," says Mulford. As a percentage of revenue, capex was 2.82% in the fourth quarter of 2009, the lowest level since 2000, according to the Georgia Tech researchers.
It's possible that the researchers' next data set will show that capex has gone up, at the expense of free cash margins. Or, "the new-found growth in the economy might boost profitability and offset the effects of increased capital spending on free cash flow," says Mulford.
What is known is that CFOs generally expect capex to rise. According to the Duke University/CFO Magazine Global Business Outlook Survey for the first quarter of 2010, finance executives reported they plan to increase their capex by 9% during the next 12 months.