Five years after the darkest days of the financial crisis, America’s corporations continue to sit on mountains of cash.
For the most part, cash has been increasingly used to buy back stock and increase dividends. And to a lesser extent, companies have been deploying that cash via capital expenditures, which represent the business spending to replace equipment and support growth initiatives.
However, Societe Generale’s Andrew Lapthorne has taken the exact opposite side of this argument. According to the data and ratios he’s looking at, “US corporates are not underspending when it comes to capital expenditure and, in fact, relative to sales they may be overspending!”
“The following chart shows overall capex to sales ratios for the US ex-financials,” he wrote. “Rather than being depressed, what we see is that capex levels versus sales are relatively elevated. If anything it would appear from this data that capex levels are too high — not too low — as many are saying.”
Considering the persistently anemic demand, Lapthorne expresses scepticism that companies will want to increase capital expenditures at this point since the increase in depreciation expense will only put further pressure on profit margins.
Indeed, if we look at the evolution of capital expenditure and cash flow growth, we see that we have already been through a long period of substantial capex growth and capex growth has exceeded cash flow growth for some time. Importantly, just as cash flow growth is slowing so too is capex growth and, in the absence of a pick-up in demand, it may continue to do so in an effort to preserve those precious high margins and profitability.
So why are corporates complaining about the lack of investment opportunities an opting largely to engage in share buybacks instead? As has been the case in Japan, we’d argue that the problem is not a lack of desire to invest, but anemic demand reflected in very low sales growth. After all, corporates did step up capital expenditure post the financial crisis only to then be confronted with a lackluster economic recovery. If the demand demand isn’t there why invest? And, of course, with credit abundant there are easier ways to boost asset prices, so why not pursue those instead?
It’s incredible that five years after the crisis, fear may be a force keeping businesses from spending.
Whether you buy his argument or not, Lapthorne reminds us that there is a risk that corporations will not ramp spending in a way that we would like.