BUSINESS WEEK: The Return of Capital Spending

Hi readers,

From these article posted on Business week, it seems that globally markets are showing early signs of recovery. With Capital spending picking up, we can expect FY2011 and FY2012 to be much better than FY2009, FY2010.  

The Return of Capital Spending

Companies that stopped capital outlays look to be starting them again, and that's a key component to global recovery

By Tara Kalwarski

Are companies ready to spend?

As the economy went into a tailspin last year, many companies stopped investing in their operations. For months they've refused to buy new computers, trucks, and other capital goods in an effort to stave off losses. The downturn in capital spending has been the worst since the Great Depression.

Now some U.S. corporations are opening up their wallets, laying the groundwork for a global recovery. A BusinessWeek analysis of companies in the Standard & Poor's 500-stock index found that 45% increased their global capital expenditures in the second quarter from the prior one. Only 19% did so in the first quarter. American Express (AXP), ExxonMobil (XOM), Verizon Communications (VZ), Wal-Mart Stores (WMT), and 106 others even upped their spending on a year-over-year basis. And those that continue to cut spending are doing so less drastically; expenditures overall have slipped just 3% in the latest quarter, vs. a 31% decline in the first. "Folks have changed their mindset toward cutting," says Steven Wieting, an economist at Citigroup (C).

The changing sentiment is another glimmer of hope for the global economy. Companies generally don't shell out money on new equipment, software, and buildings unless they think demand is picking up and profits are sustainable. The second quarter was encouraging: Earnings for the S&P 500, although still down from last year, were roughly 40% higher than in the first.

Capital spending will also be a critical growth driver in the coming years, especially given the dire state of consumers. The "expenditures will support a global recovery," says Kent Engelke, chief economic strategist at Capitol Securities Management. Already the European and Asian economies are benefiting from the uptick in spending by American multinationals. The U.S. economy, however, may lag somewhat as these companies continue to invest more of their dollars overseas. Capital spending within the U.S. fell 4% in the second quarter from the first—a bit worse than the drop in global expenditures among S&P 500 companies.

There's plenty of risk ahead. First, credit is scarce and costly, which makes it difficult to pay for outlays. St. Louis utility Ameren (AEE) spent an extra $44 million in the latest quarter, vs. a year earlier. But the company says it was a one-time bump for equipment upgrades required by regulators. "We're reducing capital expenditures," says spokeswoman Susan Gallagher. "Credit is still very expensive for us right now." Second, spending in some areas will continue to suffer for a while. Given the glut of office space and rising vacancy rates, business construction is especially vulnerable.

Better Credit Quality

The companies that are spending fall into two camps: those that are playing catch-up and those that are more optimistic about their prospects. The first group includes health insurer Cigna (CI), which increased expenditures by $16 million in the latest quarter. But Cigna's spending is off its peak, a level the company says it won't reach again until at least 2010. Such companies "cut back on capital spending much more than the fundamentals would have needed," says Milton J. Ezrati, senior economist at mutual fund firm Lord Abbett.

Companies such as American Express account for the second group. The credit-card company, which has suffered as defaults have risen and consumer spending has dropped, spent just $88 million on capital goods in the first quarter—the smallest amount since 2002. But credit quality at the company is improving: Delinquencies, those accounts more than 30 days past due, fell 14% in the latest quarter. With the problems abating, AmEx is plowing more money into the business, some $246 million in the latest quarter. At an analyst meeting on Aug. 5, CEO Kenneth I. Chenault said, "Initially our plan was to reduce investments this year by $1.5 billion.…Our intent is now to restore a portion of these investment cuts during the remainder of the year."

Some companies are allocating the extra money to technology, software, and other equipment that boost productivity. That's especially true for companies that have cut staff to the bone. "Companies can only defer CapEx for so long," says Kenneth J. Bentsen, president of the Equipment Leasing & Finance Assn., a trade group. "At some point, they have to replace their hardware and other equipment." The additional spending should be a boon for semiconductor makers such as Intel (INTC), Samsung, and Texas Instruments (TXN). Roger Wery, a partner at consultancy PRTM, expects global spending for chips to jump 33% next year.

Government largesse is spurring spending as well. The stimulus package offers subsidies for business investments in renewable energy initiatives. "There seems to be a great willingness to approve projects that serve the public interest," says Philip C. Adams, a senior bond analyst at researcher Gimme Credit in Chicago. ITC Holdings (ITC), a utility, is gearing up for green energy demand: It boosted spending to $109 million in the second quarter, a 10% increase over the previous year. "You can't change where the wind blows or where the sun shines," says ITC Chief Financial Officer Cameron M. Bready. And the company has to build infrastructure to use that energy.

Other companies are plowing dollars into new products or markets. J.M. Smucker (SJM) spent $80 million over the last three quarters of its fiscal year, up 29% from a year earlier. Most of the money went to Folgers Coffee, the brand it purchased last November from Procter & Gamble (PG) for $3 billion. Verizon is using extra funds to build telecommunications networks in Europe and India. The company estimates capital spending could top $17.8 billion this year, compared with $17.2 billion last year.

Many companies are spending on overseas operations, where they see stronger opportunities for growth. Campbell Soup (CPB) slimmed down last year by selling off Godiva Chocolatier but plans to increase capital spending by more than 30%. A growing number of the overall investment dollars have been funneled into the company's new Russian and Chinese ventures, markets in which per capita soup consumption is among the world's highest.

A truly sustained global recovery will need more big spenders like ExxonMobil. The oil giant has spent more than $10 billion so far this year, including a large investment in a new natural gas facility in Qatar. Overall, it expects to invest $125 billion globally through 2012. Says Kenneth J. Kremar, an analyst at IHS Global Insight (IHS), a research firm: "We're a ways off from a solid recovery, but the verdict is we're moving in the right direction."