Capital Spending Shows Confidence

1/20/2014


Businesses are finally getting with the program. In November, U.S. orders for capital equipment jumped 3.5% from October and nearly 11% from a year ago.

Some pundits maintain that companies' record cash balances betray a lack of confidence, but recent trends suggest the situation isn't so easily defined. Strong growth in orders and shipments for November, coupled with continued investment in inventory, suggest many businesses have the conviction to build on solid third-quarter activity.

During the third quarter, business investment in fixed goods and inventory accounted for more than half of the U.S. economy's 4.1% annualized growth. S&P 500 Index companies combined to spend nearly $150 billion on capital projects during the quarter, up 2% from the same period in 2012. In the 12 months ended in the third quarter of 2012, index companies reported capital spending of more than $577 billion, up about 3% from same period a year earlier.

Capital-spending growth has slowed in recent quarters, but it's not clear it has hit a plateau. Economic data for November imply companies continue to invest in their businesses, while history suggests they have the wherewithal to further boost spending in coming quarters.

In the last four quarters, S&P 500 companies' capital spending gobbled up 44% of their cash flow, well below the 20-year average of 56%. Capital spending, dividends, and stock buybacks consumed 90% of the cash flow, about even with the eight-year average but leaving room for continued increases in spending on all three items if cash flow continues to rise as expected.

The S&P 500 Index generated a 7.8% return on investment (net income divided by the sum of debt, equity, and other forms of financing) in the 12 months ended in the third quarter of 2013, up from 7.5% in calendar year 2012. The ROI gains demonstrate that companies have invested profitably. However, the ratio remains below levels seen in 2006 and 2007, suggesting profitability can continue to improve.

In the table below, you'll find a list of A-rated companies that have shown their confidence by boosting capital spending over the last year. To qualify for our table, the company needed growth in operating cash flow, as well as combined spending on capital projects, dividends, and stock buybacks accounting for less than 90% of that cash flow. Three intriguing options are detailed below.

Capital One Financial's ($77; COF) credit-card business has traditionally spent twice as much on marketing as its industry peers. It has also aggressively expanded beyond credit cards in the past few years, largely through a series of acquisitions. For its most recent deal, completed in November, Capital One bought Beech Street Capital, a multifamily-mortgage business based in Maryland. Terms for Beech Street, which held $3.9 billion of loans at the end of 2012, were not disclosed.

Besides credit cards (62% of revenue in the first nine months of 2013), Capital One also operates in consumer banking (28%) and commercial banking (9%). As one of the biggest lenders to U.S. car buyers, Capital One has exposure to the improving auto industry. Although some analysts worry about rising delinquencies, Capital One says the credit quality of its loan portfolio remains strong.

Capital One was expected to post December-quarter results Jan. 16, after our deadline. Analyst estimates rose in the weeks leading up to the report, with the consensus calling for earnings per share of $1.55, implying 10% growth despite a 3% revenue decline. Capital One has topped the consensus in three consecutive quarters and 15 of the past 18. The stock is a Focus List Buy and a Long-Term Buy.


Google ($1,149; GOOG) continues to protect its huge lead in global online search, capturing a 61% share of the global market in November — 53 percentage points ahead of its nearest rival. That dominant position in search provides Google with a lot of cash to fund other ventures. Operating cash flow rose 12% in the first nine months of 2013, putting Google on pace to post double-digit growth for an 11th straight year. Over the past 12 months, Google generated $18.09 billion in operating cash flow (tenth among nonfinancial stocks in the S&P 500).

Nevertheless, Google, cast in the image of co-founder and CEO Larry Page, seems set on fostering an entrepreneurial cultural rather than meeting the quarterly metrics investors use as guideposts. That partially explains why Google's capital spending, which surged 91% in the 12 months ended September, tends to be lumpy.

The company also embraces "moonshots" — imaginative, long-term projects that include internet balloons, self-driving cars, and robotic animals. The future for some, such as Google Glass or integrating Android into automobiles, might not be that far off. At the same time, Page has shown discipline, regularly sweeping the house to terminate dubious initiatives. Google announced its most recent big bet this month, the $3.2 billion cash acquisition of Nest Labs, a maker of smart thermostats and smoke alarms. Google is a Focus List Buy and a Long-Term Buy.


In fiscal 2013 ended September, semiconductor maker Skyworks Solutions ($29; SWKS) spent a record $124 million, up 32%, on capital expenditures. The money primarily funded expansion of its manufacturing capabilities. Over that period, Skyworks also set all-time highs for cash from operations, up 75% to $500 million, and free cash flow, nearly doubling to $376 million.

Skyworks has relied on the smartphone and tablet markets to drive growth in recent quarters. That momentum should carry into 2014, following Apple's ($546; AAPL) new iPhone deal with China Mobile ($50; CHL). About 80% of mobile-phone subscribers in China use slower, second-generation networks, creating a huge opportunity for upgrades. Skyworks is taking a bigger share of components in the advanced devices than it did a few years ago, a trend the company expects to continue.

Elsewhere, Skyworks is seeing rising demand for other types of devices and equipment to connect to each other, such as in the automobile and energy markets. The company has also built up its presence in health care, supplying components for hearing aids and glucose monitors. Skyworks earns an Overall rank of 100, while both sector-specific scores exceed 95. Skyworks is a Buy and a Long-Term Buy.

COMPANIES WITH CAP-EX CONFIDENCE
All 11 of the A-rated companies below grew operating cash flow and capital expenditures (cap-ex) at least 7% over the last year and still have room for more spending. Recommended stocks are listed in bold.
------ Capital Spending ------
---- Dividends ----
Stock Buybacks
---- Operating Cash Flow ----
Company (Price; Ticker)
Last 12
Months
($Mil.)
Year-
Over-
Year
Growth
(%)
5-Year
Annual.
Growth
(%)
Last 12
Months
($Mil.)
Indicated
Yield
(%)
Last 12
Months
($Mil.)
Change
In Share
Count
(%)
Last 12
Months
($Mil.)
Year-
Over-
Year
Growth
(%)
5-Year
Annual.
Growth
(%)
Cap-Ex
Dividends,
Buybacks
As % Of CFO
B/E Aerospace
($84; BEAV)
156
37
38
0
0.0
(4)
1
392
32
35
39
Boeing ($140; BA)
1,955
10
3
1,434
2.1
1,799
1
10,966
75
28
47
Capital One Financial
($77; COF)
823
103
16
466
1.6
207
1
16,191
67
13
9
Cisco Systems
($22; CSCO)
1,210
7
(2)
3,480
3.0
1,236
2
13,078
13
2
45
Ford Motor ($16; F)
6,544
37
0
1,370
3.0
197
3
9,768
7
7
83
Google
($1,149; GOOG)
6,123
91
18
0
0.0
735
2
18,090
14
19
38
Kroger ($39; KR)
2,377
21
2
311
1.7
217
0
3,482
38
5
83
McKesson ($167; MCK)
291
57
9
193
0.6
1,084
(3)
2,837
41
81
55
Medtronic ($59; MDT)
442
7
(2)
1,082
1.9
1,235
(2)
4,735
8
7
58
National Oilwell Varco
($78; NOV)
685
25
15
334
1.3
(27)
0
2,679
506
4
37
Skyworks Solutions
($29; SWKS)
124
32
14
0
0.0
182
(2)
500
75
24
61

 


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