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Corporates Show No Propensity to Increase Capex

  • By Denise Bedell
  • Published: 2/22/2016
cashpile100sRegulatory uncertainty, Congressional gridlock, global geopolitical risk and economic uncertainty are all putting a damper on corporate expectations—and inhibiting corporate planning and investment.

Capex at pre-crisis levels

During the 2008 recession, capital expenditures relative to revenues declined by about 20 percent, but have since recovered to pre-recession levels, said Charles Mulford, Invesco chair and professor of accounting, Scheller College of Business, Georgia Institute of Technology. “Those lost capital expenditures have found their way into increased cash dividends and stock buybacks and to increased holdings of cash and short-term investments on corporate balance sheets,” he said.

For U.S. non-financial firms, capital expenditures have averaged approximately 4.42 percent of revenue over the past three years. “I see no reason why capital expenditures would move above those levels,” Mulford said. “That means that if nominal growth in the U.S. economy stays in the 4 percent to 5 percent range, capital spending should grow at about the same rate. It's a positive number, but not enough to get excited about or to reduce the significant cash levels that corporations hold.”

Companies continue to favor capital return programs and short-term investments, rather than increasing capex, to make use of their excess liquidity. And that is likely to continue in the coming year. Many companies are still in the process of executing on existing share buyback programs, for a start.

One small change in 2016, given that cash balances are less likely to grow this year than they have in the past, is that in some instances, new programs may be smaller and companies may not be as likely to extend or build on existing buyback programs. “I don’t see any dramatic rises in that activity [in 2016],” said K.C. Brechnitz, senior managing director of Ernst & Young Capital Advisors. “Those companies that have them in place will continue to execute on them, but we will see no big changes, otherwise.”

The Fed effect

Uncertainty over Federal Reserve’s interest rate hikes is clearly going to continue to be a key issue hindering investment in 2016. “We are not seeing an economy that is overheating, that needs interest rates to rise,” Brechnitz said.

According to Guillermo Gualino, vice president and treasurer at Agilent Technologies, the biggest risk to capex is whether the Fed’s rate hike cycle could trigger a recession. “Typically, shareholder capital returns are not immediately affected by changes in interest rates, inflation or growth,” he said. “However, I think most companies could be making changes to the financial policy of returning cash to shareholders if there is enough pressure to deliver balance sheets to reduce default risk. I do not see that happening unless we enter into a long recession cycle, which I give a low probability.”

Capital raising

According to Eugenia Collis, senior vice president and corporate treasurer at Discovery Communications, even if rates rise, the net impact for capital raising plans will not be significant. “In the low interest-rate environment over the last few years we took advantage of issuing cheap, long-term debt and lengthened our weighted average maturity,” she said. “Rates are still at fairly low levels and the markets are showing the deepest demand for 10-year paper.”

Although the impact of slowly rising interest rates may be minimal in the short term, “all these factors will probably make it even more difficult to determine the best time to go to market,” Gualino said. “The market windows will be shorter, this year.”

The Fed declined to enact a rate rise at its January meeting, and some Fed talking heads have since indicated that they would carefully weigh market conditions in considering further hikes this year. But one of the key headwinds in 2015 was not just uncertainty but contradictory talk from different FOMC members on when—and how much—rates would rise. A united front from committee members, and clear guidance on timing, would go a long way to helping corporate executives plan investment—one way or another.

A longer version of this article will appear in an upcoming edition of AFP Exchange.
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