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Feb 04 2014

Business Spending Should Rise

By Jason M. Mengel for Island Eye News

Companies that survived the financial crisis in 2008 have spent the last five years rebuilding their financial health, and in the process, have accumulated record amounts of cash. Until recently, the primary use of this cash has been to reward shareholders by raising dividends and buying back shares, as CEOs remained cautious from our slowly improving economy. Going forward, we are encouraged to see companies now shifting more towards business investment, which will benefit our economy and global competitive positioning.

The Growing Cash Hoard

The financial crisis of 2008 not only taught consumers the dangers of too much debt, but also led many over-levered companies into bankruptcy. The ones that survived learned a brutal lesson, and they have spent the past five years reducing debt and firming up their balance sheets. Just as consumers postponed purchases on automobiles and home appliances as they repaired their personal balance sheets, companies also extended the replacement cycles of their machines and technology systems in order to keep costs under control. Furthermore, the majority of CEOs and CFOs were watching the economy recover at a pace that kept them hesitant to invest in new growth initiatives. The combination of reduced expenses and debt reduction led to a record amount of cash sitting on balance sheets. To put this cash generation into perspective, companies in the S&P 500 currently hold a combined $3.4 trillion in cash on their balance sheets. These large cash balances have earned no interest (much like savers have earned no interest on their cash), and therefore, management made the decision to give the cash back to shareholders in the form of dividend raises and stock buybacks.

Shifting Focus Back to Growth

As we enter the New Year, there appears to be a developing shift in the use of cash from shareholder friendly activities to investment in future earnings growth. Recently announced capital expenditure (capex) projects- including replacing machinery, opening new facilities, and investing in new technology systems- give us confidence in our forecast.

Notable projects announced recently include:

  • Ford is planning to increase capex by $1 billion, to $7.5 billion total, to add capacity as auto sales surpass levels not seen in seven years.

  • Microsoft announced its intention to double investment in 2014 to $6.5 billion for new data centers and networking equipment in order to compete against new and disruptive technologies.

  • Honeywell plans to invest $1.2 billion to build new chemical factories in Louisiana and Alabama, which is a 33 percent increase from last year.

We are encouraged to see this newfound interest in capex spending for three key reasons:

1. Investing in Growth: Our economy is improving, albeit slowly and steadily, and the risk to invest in capex projects today is far lower than five years ago. Companies in the U.S. must compete on a global scale now, and the old adage of “spending money to make money” reigns supreme.

2. Boost to Economy: Businesses tend to lag consumer spending in a recovery, and a rise in capex will further add to our gross domestic product (GDP).

3. Equities Have Risen: Given the rise in equities over the past three years, buying back stock cheap is more difficult to achieve. We get concerned when we see management teams announce buybacks after their stock has risen dramatically so a shift to better capital use is welcomed.

Implications for Investors

Imagine if Apple had not approved the investment into the first iPhone, or energy companies had never pumped billions into research and development (R&D) for fracking to extract shale oil and gas. This would be a world that may never know what U.S. energy independence could do for our economy, or even worse, a world where we may never know the satisfaction of carrying 5,000 songs on a smartphone at any given time.

The bottom line is that investment into future growth is not only beneficial to our society but also to the returns for long-term investors. Cash currently generates a negative return once inflation is considered, and therefore, we strongly prefer the cash be used towards new capex projects as project risk drops from our slow and steady economic recovery.

This commentary is not intended as investment advice or an investment recommendation. It is solely the opinion of our investment team at the time of writing. Fusion Capital is a Registered Investment Advisor firm. If you have comments or questions, please contact Jason Mengel at jmengel@fusioncapital.net or call 843.972.0065.

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