Cash Speaks Volumes

3/21/2011


Benjamin Franklin is commonly credited with the adage: "Believe none of what you hear, and half of what you see." Those words still resonate more than 200 years later, warning us about the dangers of taking corporate executives’ words at face value.

In recent months, many business leaders have made conservative statements about the future, citing economic and business risks. With many of the economy’s thorniest questions still unanswered, some caution seems wise. But if you want to find out what America’s business leaders really think, consider the advice Deep Throat famously gave journalist Bob Woodward as he investigated the Watergate scandal — "Follow the money."

Corporate America’s money speaks with less restraint than that shown by its leaders. Over the last 12 months, the 438 components of the S&P 500 with four years of data committed $410 billion to capital projects, up 10% from $374 billion a year earlier though still well below the $474 billion spent two years earlier.

Far fewer firms report research and development spending — some companies have no R&D budget, while others include such costs in capital spending or other line items. However, the 186 S&P 500 companies with four years of data combined to grow their R&D spending 12% to $155 billion in the last 12 months, after a 7% decline in the year-earlier period.

That spending — designed to increase production capacity and fund the development of new products — suggests businesses are increasingly confident that demand for their wares will increase going forward. (For a peek at which S&P 500 companies are the most confident, visit www. DowTheory.com/Go/Spend.)

Consensus estimates suggest we at the Forecasts are not the only ones who give the money more credence than the words. The market’s per-share-profit expectations for the S&P 500 Index have risen this year, with the targets for 2011 and 2012 up at least 1.6% from expectations at the start of this year. Wall Street currently projects 14% growth in both years, numbers the index is unlikely to reach without solid sales growth. R&D and capital-spending trends suggest companies expect to see that growth.

The table below lists companies that are confident, with good reason. All 11 of the A-rated companies boosted their spending on capital projects over the last year and are expected to deliver double-digit profit growth this year and next year. Four are reviewed in the following paragraphs.

In recent years, Advance Auto Parts ($65; AAP) has focused on improving its customer service, pricing, and availability of parts. Investments have ranged from additional trucks for the commercial unit to beefing up the e-commerce infrastructure. Advance Auto’s Web site, launched in October 2009, is seeing higher traffic, conversion rates, and sales. To support projected growth, Advance Auto is investing in a new warehouse-management system and a new distribution center, set to open late this year in Indiana. Management projects capital expenditures of $275 million to $300 million in 2011, the company’s highest ever and up from $200 million last year.

Advance Auto is only beginning to experience the payback from many of its investments, which should continue to push same-store sales higher and expand gross profit margins. For 2011, Advance Auto sees same-store sales rising in the low to mid single-digits, likely extending a trend of higher annual comparable sales stretching back at least 14 years. Advance Auto delivered 8.0% higher same-store sales in 2010. Advance Auto Parts is a Focus List Buy and a Long-Term Buy.


CSX ($75; CSX) plans to spend $2 billion on its rail network in 2011, up 10% from 2010, to stay ahead of rising demand from domestic manufacturers and consumers in Europe and Asia clamoring for more U.S. coal. CSX’s increase falls roughly in line with the overall freight-rail industry, expected to invest $12 billion this year on hiring, laying new track, and other capital projects.

About 56% of CSX’s capital spending will go toward infrastructure, with 15% reserved for rolling stock, such as locomotives and rail cars. CSX plans to plow 16% of spending into strategic investments, including construction of a terminal in Northwest Ohio, slated for completion in the first half of this year. The terminal is part of a larger initiative to increase intermodal capacity between Mid-Atlantic ports and the Midwest. CSX funds these investments with cash provided by operations, which surged 58% to $3.25 billion in 2010.

Wall Street estimates project 32% higher per-share profits in the March quarter on 8% revenue growth. For the year, CSX’s earnings are expected to rise 23%, with revenue up 9%. CSX is a Focus List Buy and Long-Term Buy.


DirecTV ($45; DTV) increased capital spending 17% to $2.42 billion last year, roughly in line with growth in operating cash flow. Over the past three years, DirecTV has spent $300 million (4% of total capital expenditures) on its satellites, including the construction of two new devices that expand its fleet to 12. An additional satellite is under construction, slated for completion in the second half of 2013. These satellites should last a minimum of 12 to 16 years.

DirecTV funnels the rest of its capital spending toward property and equipment, including the set-top receivers leased to new subscribers. Within the U.S., DirecTV’s spending on receivers held steady in 2010 after declining in the two prior years, the result of lower costs and the use of refurbished equipment.

For 2011, DirecTV anticipates slightly higher capital expenditures in the U.S. and a bigger increase in Latin America, lifted by subscriber additions, higher sales of advanced products, and other infrastructure projects. DirecTV is a Focus List Buy and a Long-Term Buy.


Exxon Mobil ($81; XOM) was one of few energy companies to expand capital spending throughout the recession, ratcheting up expenditures by 16% in 2009 and 19% in 2010. The strategy is paying off. Exxon’s proved reserves of oil and natural gas rose by 3.5 billion barrels of oil equivalent last year — the largest gain since 1999 and more than double 2010 production. Natural-gas reserves accounted for most of the increase, largely the result of the $25 billion acquisition of XTO.

Exxon plans to increase spending for exploration and refining by 6% to $34 billion in 2011 and forecasts annual expenditures of $33 billion to $37 billion for the next several years. Management seems inclined to focus on oil, trading above $100 per barrel, rather than natural gas, still weighed down by a production glut in the U.S.

New projects scheduled to come on line in the next few years should help add 1.4 million barrels of oil and gas equivalent to Exxon’s daily production, versus current production of 4.4 million barrels per day. Oil is expected to account for 80% of that new production, up from about 50% of last year’s total production. Exxon Mobil is a Focus List Buy and a Long-Term Buy.

CONFIDENT COMPANIES
All 11 of the A-rated companies below have increased their spending on capital projects over the last year. All also earn solid Quadrix® Overall scores, enjoy rising profitability, and seem capable of double-digit per-share-profit growth this year and next year. Recommended stocks listed in bold.
Capital-Spending
----- Change -----
R&D-Spending
----- Change -----
Oper. Profit
------- Margin -------
Return On
---- Investment ----
Est. EPS
---- Growth ----
Company (Price; Ticker)
Last
Year
(%)
1 Yr.
Earlier
(%)
Last
Year
(%)
1 Yr.
Earlier
(%)
Last 12
Months
(%)
1 Yr.
Earlier
(%)
Last 12
Months
(%)
1 Yr.
Earlier
(%)
This
Year
(%)
Next
Year
(%)
Quadrix
Overall
Score
Adobe Systems
($33; ADBE)
42
7
20
(15)
27
25
12
8
19
12
90
Advance Auto Parts
($65; AAP)
3
4
NA
NA
10
8
25
18
19
12
90
Agilent Technologies
($44; A)
13
(23)
0
(10)
16
10
17
0
32
14
96
Apache ($118; APA)
241
(39)
NA
NA
47
6
12
NM
24
12
79
CSX ($75; CSX)
26
(17)
NA
NA
29
25
10
7
24
16
94
DirecTV ($45; DTV)
17
(7)
NA
NA
16
12
20
9
25
33
97
DuPont ($52; DD)
15
(34)
20
(1)
12
10
16
11
12
12
72
EMC ($26; EMC)
81
(41)
16
(10)
16
12
10
6
17
15
81
Exxon Mobil
($81; XOM)
19
16
NA
NA
12
10
20
16
19
12
95
Hess ($79; HES)
88
(34)
NA
NA
9
7
11
4
29
16
96
Union Pacific
($93; UNP)
4
(14)
NA
NA
30
24
10
7
18
17
84
Note: Quadrix scores are percentile ranks, with 100 the best.    NA Not Available.    NM Not Meaningful.

 


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