For months, nonfinancial companies have put off spending on capital needs and hoarded cash. But for the first time since the financial crisis, they are increasing their capital spending — even as they fill their coffers.
This new condition has been met with some positive sentiment by at least one analyst who tracks cash-flow data. For Chuck Mulford, a professor of accounting at Georgia Tech and director of the university’s Financial Analysis Lab, “it’s the first truly healthy sign since before the recession.”
“When the recession began, we expected to see free cash flow fall off the face of the earth because the recession was so deep. It started to fall, and then it took this very unexpected turn upward,” he says.
In an analysis of 2,922 companies ranging from agricultural to rubber and plastics, Mulford’s latest report shows that free cash margin (free cash flow as a percentage of revenue) increased during the fourth quarter of 2011 after six straight quarters of declines. Free cash margin for firms with a market capitalization greater than $50 million rose to 4.54% for the 12 months ended December 2011, up 0.13% from 4.41% in September 2011, according to data supplied by Cash Flow Analytics, a firm where Mulford serves as director of research.
In the midst of the recession, firms cut capex, which did give a lift to cash flow. But those cuts stemmed largely from conscious efforts to lower head count and reduce expenses. In the 12 months ended December 2011, however, capital expenditures rose to 3.41%, up from 3.29% recorded in September.
Such a convergence of forces has been rare. “This is the first reporting period since before the recession that we’ve seen increased spending on capital expenditures and increases in inventory [while] no longer seeing a decline in free cash flow margin,” Mulford says. “We’re seeing an uptick. We haven’t seen that now in years.”
Defense firms in particular improved their free cash–margin performance over the year. Free cash margin for the defense industry rose to 10.14% for the 12 months ended December 2011, which is up from 5.53% in September 2011 and 4.20% over the 12 months ended Q4 2010.
The increase in defense cash flows comes despite an overall reduction in government spending. The Department of Defense recorded $528.2 billion for its discretionary base budget for 2011, which is down from $530.8 billion in 2010.
“The defense contractors are doing a remarkable job generating cash in the face of a difficult operating environment,” adds Mulford.
Construction materials and the coal industry, in contrast, had some of the worst free cash margins last year. Free cash margin for the construction-materials sector fell to 0.97% from 2.59% in September 2011. Similarly, free cash margin for the coal industry declined to 3.06% last year from as high as 8.05% in September 2011.
That was a marked contrast to the overall bounce in free cash flow. Yet one upward move in cash flow does not make a trend just yet. “We might see another downturn, but this is the healthiest I’ve seen it,” notes Mulford. “Anytime you have an economy that’s growing at 2.2%, you’re always on the precipice of falling backward. These are positive results for which the CFOs that run these companies should be applauded . . . but you can’t let up.”