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Sitting Tight: The 2005 Capital Spending Scorecard

Our second annual capital spending scorecard shows that many, if not most, companies have reason to be wary about new spending.
Ronald Fink, CFO Magazine
December 1, 2005

After two years of decline, U.S. companies increased their capital spending modestly in 2003 and 2004, but the amount is still sharply lower than its peak in 2000. Petrochemical companies led the rebound, investing billions to upgrade old refineries and increase capacity, while the electronics and telecommunications sectors continued to cut spending.

Still, U.S. companies' spending has trailed that of businesses in Europe and Asia for the past four years, according to this magazine's second annual survey of capital spending. Total capital expenditures (capex) for the 50 largest spenders in the United States fell slightly during the period, although sales increased 9 percent a year between 2001 and 2004. In contrast, their European and Asian counterparts increased capital spending by 1.4 percent and 6.1 percent, respectively. Europe's biggest spenders have posted sales growth of 4.2 percent a year since 2001; Asia's big spenders recorded annual sales increases that averaged 9.7 percent.

CFO magazine's survey of 300 U.S. companies was prepared by Pittiglio Rabin Todd & McGrath (PRTM), a consultancy based in Waltham, Massachusetts. The study examines capital spending trends domestically and globally from 2001 to 2004. PRTM also ranks the 20 largest companies in the most capital-intensive industries in the United States, Europe, and Asia by their adjusted return on gross fixed assets, or ROGFA (see "Measuring Capex" at the end of this article).

The study holds a mixed bag of news for economists who consider capital investment the key to a robust and sustainable recovery. There has been widespread fretting for the past two years as the nation's biggest companies have opted to squirrel away cash, buy back shares, or pay dividends rather than spend on new equipment and factories. U.S. capital spending among companies surveyed rose to $228 billion in 2004, up 6 percent from $215 billion in 2003 in a trend led by a broad cross-section of industries.

In addition to the petrochemical industry, the study's biggest spenders in terms of total dollars include aerospace and defense firms, automotive companies, industrial manufacturers, pharmaceutical companies, telecommunication providers, and utilities. Six sectors increased capex spending between 2001 and 2004: aerospace and defense, food and beverage, industrial manufacturing, medical devices, petrochemicals, and pharmaceuticals. Seven sectors decreased spending: electronics, metals, semiconductors, transportation services, telecom service providers, telecom-equipment manufacturers, and utilities.

The question going forward, however, is whether companies can earn a satisfactory return on that spending, and here the study is not especially reassuring. On average, returns in the industries that account for most U.S. spending, telecom service providers and petrochemical makers, trail those in other industries.

Among the top 10 individual spenders were General Motors Corp. and Ford Motor Co., whose serious financial troubles put new spending in doubt. As it was, capex spending by the auto sector was flat last year, at about $21 billion, compared with 2003. Of the other top 10 individual spenders, all but Intel Corp. were telecom service providers or petrochemical companies.

As this issue went to press, oil companies faced the possibility of a windfall-profit tax. U.S. telecom service providers, meanwhile, have cut their budgets dramatically since 2001. They spent $47 billion in 2004, thus accounting for nearly one-fifth of the total capital spending of the companies surveyed by PRTM. In contrast, the group had spent $94 billion in 2001.

To be sure, Verizon Communications Inc., whose $13.3 billion budget in 2004 makes it the single largest spender among the companies in the survey, has bucked the trend. And in October, the company said it plans to boost its spending by about 15 percent in 2005 and by as much as another 26 percent in 2006. But Verizon's adjusted ROGFA is 15 percent, lower even than the sector's subpar average of 16 percent. "We are continuing to make investments in wireless, broadband," and business services, Verizon CEO Ivan Seidenberg said in late October. Investors, however, seem to worry that such spending will hurt the company's earnings.

In contrast to the telecom sector, petrochemical companies have boosted spending each year since 2001. The sector, the most capital-intensive of all in the United States, accounted for more than a quarter of total capital expenditures in 2004, according to the survey, up from 16 percent in 2001. Total spending among the petrochemical companies surveyed rose to $58 billion in 2004, up 31 percent from $44 billion in 2001.

Not surprisingly, rising oil prices have spurred a race to increase capacity and efficiency. Yet the industry's average adjusted ROGFA of 19 percent lags that of such industries as aerospace and defense, medical devices, pharmaceuticals, food and beverage, and even chemicals.

A lot may be riding on this industry, since a growing number of experts predict that oil supplies will have to be supplemented with alternatives. While some of the big oil companies are taking steps to develop such alternatives, the process will take years. Meanwhile, refiners will have to plug the gap. Here, however, there is at least one hopeful sign: the nation's largest refining company, Valero Energy Corp., has been the most profitable spender in the oil patch since the late 1990s. That record reflects a series of acquisitions, including its recent $6.9 billion purchase of Premcor, in Old Greenwich, Connecticut. "We bought lots of refineries at a fraction of their replacement cost," says Valero CFO Mike Ciskowski. The company has been investing heavily in its refineries to meet environmental standards and to increase capacity. Valero's adjusted ROGFA is 31 percent, the best of the petrochemical companies surveyed.


San Antonio–based Valero spent $1.6 billion on capital expenditures in 2004. As for the future, "there's a big backlog of projects," says Ciskowski. The company's spending will double this year, and could continue to increase for the next several years if Valero's cash flow remains as strong as it has been.

If only other companies were in such a position.

Ronald Fink is a deputy editor of CFO.


Measuring Capex

To find out how the 300 companies in its sample fared in terms of return on capital spending, Pittiglio Rabin Todd & McGrath ranked the top and bottom four companies in each industry according to their 2004 earnings before interest, taxes, depreciation, and amortization divided by the book value of their fixed assets and adjusted to eliminate the balance-sheet effect of operating leases. The resulting ratio — adjusted return on gross fixed assets (ROGFA) — reflects how much a company earns on its property, plant, and equipment. But since that number can be boosted by a decline in asset value, the consulting firm's scorecard also shows how much those companies spent in 2004 and how that amount has changed since 2001. To complete the picture, the analysis also shows a company's degree of capital intensiveness and its revenue growth and shareholder returns.

Granted, ROGFA may not be the most appropriate measure to determine whether to, say, build a new plant or outsource manufacturing. For that type of decision, a metric that takes into account a company's cost of capital is generally more appropriate. But such measures provide too broad a perspective for assessing capex productivity. For one thing, they assume that assets fully depreciated for tax and accounting purposes have no value, when in fact most companies spend money to maintain tangible assets even after they have been fully written off. They also include working capital. As a result, ROGFA can be more useful in helping companies understand how efficiently they are deploying capital on those assets. — R.F.




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