Cap-Ex Can Still Be A Wise Investment

7/18/2016


Earnings season, when investors get bombarded with executives cheerfully puffing up their companies' prospects, has begun. A better gauge of executive confidence is the amount of capital they're willing to commit to new equipment and facilities.

Capital investment for the S&P 500 Index fell 9% last year, its first annual decline since 2009, primarily due to cutbacks in energy and telecom.

No good deed goes unpunished
We separated the S&P 500 Index into quintiles based on the change in 2015 capital expenditures. The highest quintile averaged 45% growth in capital spending in 2015 but has underperformed three of the four other quintiles this year. Energy stocks, among the strongest performers this year, dominate the lowest quintile. The third quintile features many financial stocks, the weakest performers. All numbers are averages.
2015
Cap-Ex
Change
(%)
YTD
Total
Return
(%)
Est. EPS
Change,
2016
(%)
Highest Quintile
45
7
9
Quintile 2
13
11
3
Quintile 3
1
3
3
Quintile 4 
(7)
12
6
Lowest Quintile
(30)
13
4
Note: Change in capital expenditures was capped at 75% and -75%.

S&P 500 companies that increased capital spending the most in 2015 have not necessarily been rewarded by investors this year. We separated the S&P 500 Index into quintiles based on their 2015 change in capital expenditures, as shown in the nearby table.

The top quintile averaged 45% growth in capital spending last year, but its stocks averaged total returns of just 4% so far in 2016, lagging three of the other four quintiles. However, their 2016 operating momentum should benefit from the higher investment. Stocks in the top quintile on cap-ex growth are expected to grow earnings per share an average of 9%, a faster rate than any of the other quintiles.

If markets hate uncertainty, so do corporate executives. The U.K.'s decision to leave the European Union could create a lull in capital spending, especially for companies with operations in Britain. However, U.S. companies produce 70% of their revenue domestically, says Barron's.

Even before the Brexit vote, U.S. companies appeared cautious. New orders for durable goods — products expected to last at least three years — slipped a seasonally adjusted 2.2% in May from April, according to the U.S. Commerce Department. New orders for nondefense capital goods excluding aircraft — a common proxy for business investment in equipment — fell 3.5% in the first five months of 2016, compared to the same period last year.

An emphasis on returning capital to shareholders may be crowding out capital investment. Last year, S&P 500 companies devoted more than 37% of earnings to their dividends, higher than any year since 2009. Moreover, S&P 500 companies spent $161.4 billion on stock buybacks in the March quarter, up 12% year-over-year, second only to the September 2007 quarter's $172 billion.

Nowhere has the capital-spending downturn been sharper than in the energy sector, where S&P 500 members averaged spending declines of nearly 20%. However, confidence among the biggest drillers may be starting to recover. With oil prices showing signs of stabilizing, BP ($37; BP), Chevron ($107; CVX), and Exxon Mobil ($95; XOM) have all approved multibillion-dollar projects since late June.

Investor sentiment may also be starting to turn in favor of capital expenditures. A global survey conducted by Bank of America Merrill Lynch this spring found that 73% of fund managers say companies are spending too little on capital investment.

Below we profile three recommended stocks that have grown cap-ex at least 18% so far this year.

Amerco's ($389; UHAL) cash from operations jumped 29% to $1.04 billion in fiscal 2016 ended March. Aside from occasionally paying an irregular dividend, Amerco pumps most of its excess cash back into its business. Amerco added about 4,000 rental trucks in fiscal 2016, bringing its fleet to 139,000 vehicles. Yet rental-truck demand still exceeded supply. In the coming year, the company plans to invest $600 million in trucks and trailers, net of equipment sales, up from $365 million spent in fiscal 2016.

For its self-storage business, Amerco invested $592 million last year on real estate, new construction, and renovation, up 61%. These efforts expanded the company's square footage 18%, up from 12% growth in fiscal 2015.

Management's recent investments are paying off. Annual returns on assets and investment reached their highest levels since at least fiscal 1981. Sales grew 7% in fiscal 2016 and earnings per share increased 24% as operating profit margins rose for the fourth consecutive year. Amerco is a Focus List Buy and a Long-Term Buy.


Disney ($100; DIS) has increased annual capital spending more than 15% in each of the past two years and more than 5% in seven of the past 10 years. A major focus of Disney's recent investment has centered on Shanghai Disneyland, which opened in June and reportedly cost more than $5.5 billion to build. Disney, which has a 43% stake in the park, is already drawing up plans to expand, possibly tripling the resort's size.

Management continues to try to shore up its television unit, which shed 2% of its U.S. subscribers in fiscal 2015 ended September. Disney's ESPN has lost about 7 million subscribers in the past two years, or about 7% of its subscriber base. In the past month, Disney agreed to pay $1.14 billion over six years for half of the Big Ten conference's media-rights package. The company also said it would take a stake in Major League Baseball's video-streaming business. In addition, ESPN plans to launch streaming-video service, sold directly to consumers. The service would include niche sports, rather than NFL or NBA games, but this still signals Disney's willingness to bypass the traditional cable bundle. Disney is a Long-Term Buy.


Kroger's ($37; KR) capital spending has risen by double-digits in each of the past three years. Fewer than 7% of companies in the S&P 500 Index can say that. Aside from Whole Foods Market ($34; WFM), no other publicly traded grocery store has consistently increased investment spending in recent years.

In April, management reaffirmed its capital-expenditures budget of $4.1 billion to $4.4 billion for the current year, implying 24% to 33% growth. That investment will fund the remodeling of recently acquired Roundy's stores, adding new stores in current geographic markets, and developing digital tools for shoppers.

Kroger has devoted 68% to 73% of operating cash flow to capital expenditures in each of the past five years. Excess cash has also gone toward the dividend, up an annualized rate of 15%, and stock buybacks, which have cut outstanding shares 21%. Kroger is a Buy and a Long-Term Buy.

INVESTING IN THEMSELVES
All of the recommended stocks below increased capital spending at least 10% in 2015 and the first quarter of 2016.
------------ Capital Expenditures ------------
Est. EPS
Change,
2016
(%)
YTD
Total
Return
(%)
---------- Quadrix Scores ----------
Company (Price; Ticker)
2016
YTD
($Mil.)
2016
Change
(%)
2015
($Mil.)
2015
Change
(%)
Momen-
tum
Value
Overall
Amerco ($389; UHAL)
457
18
1,233
19
5
0
79
65
89
Biogen ($251; BIIB)
127
30
643
123
11
(18)
72
80
90
CDW ($41; CDW)
11
10
90
64
11
(2)
81
78
88
Centene ($72; CNC)
45
67
150
46
39
10
96
70
98
CVS Health ($98; CVS)
598
43
2,367
11
13
1
68
64
70
Disney ($100; DIS)
1,150
27
4,265
17
5
(4)
82
58
88
F5 Networks ($116; FFIV)
17
62
60
115
5
20
74
65
91
Gilead Sciences ($86; GILD)
177
43
747
34
(4)
(14)
77
95
98
Kroger ($37; KR)
1,090
24
3,349
18
8
(10)
61
63
67
Lab. Corp. of America ($136; LH)
71
111
256
26
11
10
94
66
93
Lam Research ($89; LRCX)
46
44
206
10
0
12
64
78
94
LKQ ($33; LKQ)
50
93
170
21
27
12
78
55
89
Robert Half International ($39; RHI)
19
41
75
19
10
(16)
53
89
84
Shire ($192; SHPG)
52
131
115
49
7
(6)
38
59
73
Note: Quadrix scores are percentile ranks, with 100 the best.

 


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