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The drought in corporate capital investment continues Print E-mail
Friday, 23 April 2010

By Ronald Fink

Despite signs of an economic recovery, US companies continued to cut capital expenditures as recently as the fourth quarter of last year, according to a report released Thursday.

The report, published by the Financial Analysis Lab of the Georgia Institute of Technology, shows that 3,876 US companies with a market capitalization of at least $50 million reduced their capital spending to 2.82 percent of trailing 12-month revenue in the last quarter of 2009, from 3.02 percent in the third quarter.

The percentage for the fourth quarter is the lowest level of capex recorded by the lab since it began collecting data in 2000. The figure bottomed in the 2001 recession at 4.1 percent.

The decline calls into question companies' confidence in an economic recovery, said the authors of the report, Charles Mulford, an accounting professor at Georgia Tech who directs the lab and is an advisor to CFOZone, and graduate research assistant Brandon Miller.

"Our expectation is that as the economy grows, it will be necessary for companies to once again begin increasing their fixed asset base," wrote Mulford and Miller.

To be sure, the reduction in capex, along with continued cost cutting, helped companies improve their cash margin -- the amount of free cash flow from operations as a percentage of revenue -- to 6.56 percent in the fourth quarter of last year, the highest level since 2000, from 5.36 percent in the previous quarter.

Meanwhile, the study showed that companies' gross margins improved to 36.78 percent in Q4 from 36.39 percent in Q3 as sales, general and administrative expense fell to 14.68 percent from 14.84 percent.

Fourteen industry sectors reported improved free cash margin from the same period in 2008, while no sectors saw free cash margin decline. Six sectors saw their free cash margin remain relatively stable.

Companies have achieved higher cash margins even in the face of declining revenues. The study showed revenues have declined for each four-quarter reporting period since the period that ended in December 2008, though the rate of decline slowed markedly in the December 2009 period.

"Companies have learned to maximize free cash flow," Mulford wrote in an email accompanying the report.

But he said the improvement in cash flow won't last unless the economy improves dramatically. Just increasing capex back to 4 percent of revenue from the Q4 level would cut free cash flow generation by about 18 percent, Mulford observed.

"Companies are looking for confirmation that the recovery has taken hold before increasing capital spending again," he continued. When they do, the increases in capital spending will put pressure on free cash margin. "What remains to be seen is whether a new-found growth in the economy might boost profitability and offset the effects of increased capital spending on free cash flow," he added.

The study did contain one hint of good news regarding growth: While inventories and receivables were reduced during the depths of the recession, inventory days increased to 25.43 days from 24.52.

Mulford suggested this might be a sign that companies are more confident. "Working capital needs to grow to support future revenue growth," he said. He said that was particularly true of inventories. "Now they're growing again and I think that it's an indication that they are anticipating a recovery."

But the study shows that the confidence reflected in rising inventory levels has yet to show up in capex.

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