It’s been a long-standing gripe of the RBA that in an era of record-low interest rates, Australian companies have been hesitant to make large-scale capital investments.
And the central bank’s latest monthly chart pack illustrates that business investment remains low, despite a consistent improvement in Australian business conditions and a steep decline in the level of interest payments.
The charts show why rising household debt and low wage growth continue to weigh on Australian consumers. (Today, the ABS reported a shock 0.6% decline in retail sales for the month of August, a huge miss on the 0.3% increase expected.)
The increasing gap between business and consumer confidence has been well-documented in 2017. NAB’s monthly survey of business sentiment peaked at a 9-year high in July and remains elevated. Meanwhile, the leading consumer confidence surveys consistently reveal that Aussie consumers remain downbeat.
In that context, the RBA’s latest chart pack revealed some interesting trends. For one thing, it shows commerical investment has been on a steady decline despite the rise in business conditions.
This chart shows the fall since the mining boom peaked in 2012:
Given the capital intensive nature of large mining projects, one would expect investment to decrease somewhat as Australia transitions into a services-based economy.
But the fall has been steep and consistent – leaving business investment as a percentage of GDP at its lowest point since the 1990’s. (Importantly, the decline appears to have stopped.)
And while mining investment has dipped, capital expenditure within other areas of the economy has flatlined:
At the same time, investment conditions would seem to have been conducive to capital expenditure.
Years of central bank stimulus since the global financial crisis (GFC) in 2008 have kept interest rates low — generally a favourable environment in which to borrow money for investment.
In fact, the next chart (right hand side) shows how interest paid on commercial debt has been steadily declining since the GFC, when measured as a percentage of company profits:
But importantly, the left side of the above chart shows that while borrowing costs have reduced, Australian businesses have been hesitant to invest using debt. Instead, business credit as a percentage of nominal GDP has remained stagnant.
Perhaps business conditions are so good that Australian companies have been able to self-fund projects. But research from Credit Suisse analyst Hasan Tefvik during the August company earnings season shows that Australian companies typically don’t place a high focus on reinvesting capital.
This chart by Tefvik shows that since the mining boom, forward guidance by ASX200 companies (excluding financials) for capital expenditure has generally declined in each reporting season:
It forms part of Tefvik’s analysis which indicates that ASX200 companies are actually planning to spend some money on capital investment. And Tefvik noted that the reinvested capital will come at the expense of dividend payments.
Instead of capex, most larger Australian companies have historically allocated profits towards paying a strong dividend. Based on the reaction to Telstra’s announcement of a dividend cut in August — Telstra shares crashed by 10% — it would appear that market expectations for that to remain the case are still high.
Indeed, Telstra’s operational profit was around market forecasts. So the dividend drop wasn’t as a result of falling profits — rather just Telstra communicating that it was placing a strategic focus on capex.
A shift towards capital reinvestment would mark a significant change in strategy for Australian companies, and it may have flow-on effects to other areas of the economy such as wage growth.
Consistently low wage growth remains a key area of concern for long-suffering Australian workers. And when it comes to consumer confidence, the problem is exacerbated by rising household debt.
That is well illustrated in this RBA chart, which shows household debt close to doubling the amount of household disposable income:
As part of ANZ’s weekly consumer sentiment survey, the bank’s Head of Australian Economics David Plank has consistently said a pickup in wage growth would be required before any significant rise in confidence.
So far, historically high business conditions have failed to translate into a meaningful pickup in wage growth. And those business conditions aren’t just based on sentiment — hard data shows that corporate profits (excluding financials) are on the rise, while private sector wages remain stuck in the mud.
Research from Commonwealth Bank in July clearly shows the recent divergence:
The latest business confidence index did provide some cause for optimism that wages may rise, as businesses reported higher employee costs for the month of August.
However, a more consistent stream of data will be needed before that optimism turns into tangible results. And this morning’s bad miss in retail sales will add to concerns that Australian household finances are under pressure.
As for a paradigm shift in Australian business investment, we’ll soon find out whether improving business conditions and a positive global growth backdrop will drive other big companies to follow Telstra’s lead and focus their resources on increased capital expenditure.
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