Captains of Capex

Some companies have outpaced the field in capital investments even as they've kept the cash flowing. What are their secrets?

To reverse the cliché, every silver lining is covered by a cloud. That’s something CFOs should remember as they focus on a metric that most hold dear: free cash flow. For many finance chiefs, the ability to liberate cash from revenue and its attendant costs gets at the very heart of their value to the organization.

Investors, boards, and chief executives tend to regard such free money as a cloudless benefit. But free cash flow isn’t completely free, particularly if it is generated at the expense of a company’s (not to mention an economy’s) ability to grow.

During the financial crisis, many corporations shifted into survival mode, slashing expenses in order to maintain enough liquidity to pay down debt or provide a backstop against future financial meltdowns. Unfortunately, a big portion of that ax-wielding entailed cuts to long-term productive corporate assets like property, plant, and equipment.

Two diverging trends tell the story. After reaching a three-year low of $14 million in December 2008, reported median free cash flow for about 4,000 U.S. public non-financial-services companies soared, doubling to about $28 million by March 2010 (according to a study by the Georgia Tech Financial Analysis Lab using data provided by Cash Flow Analytics).

That marked the highest level of free cash flow in at least 10 years. On the other hand, starting in March 2008, reported median net capital expenditures (capex) as a percentage of revenue plunged to less than 3% in March 2010, a 10+ year low.

Together those two metrics tell a dark tale indeed, say some experts: the drastic cutbacks in capex amount to firms swapping long-range economic health for a short-term glow to please (or at least appease) investors. “Over the last few quarters, free cash has been growing for many companies, but they’ve been achieving it in nonrecurring ways,” says Charles Mulford, a professor of accounting at Georgia Tech and managing director of research for Cash Flow Analytics. Those ways include “the crutch of reducing capex to grow free cash flow,” he says, along with reducing inventory and expenses.

Companies have boosted free cash flow since 2008, but capex has plunged.

There is no denying that in this still-uncertain economy, holding tightly to your cash can make a great deal of sense (see “Time to Get Off Your Cash?” July/August). And, along with preserving liquidity, another reason for capex caution may be that boosting capex could run counter to the perpetual push for manufacturing efficiency: how “lean” can a company be if it’s pouring money into plants and equipment?

Pretty lean, as it turns out — at least in some cases. A few large public companies have maintained an upward trend in capex as well as healthy free cash flow over a relatively long period, according to an analysis of Cash Flow Analytics data conducted for CFO by Mulford. Six U.S. public, non-financial-services companies with market caps of more than $1 billion grew their capex/revenue ratios by more than 10% over the one-year and three-year periods ending in March 2010, even as they maintained positive free cash flow.


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