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Capital Choices: The 2004 Capital-Spending Scorecard

A new study shows which companies are getting the most bang for their capital-investment buck.

Spending on Innovation

Of course, some industries, including chemicals and heavy manufacturing, are particularly cyclical and therefore face troughs and peaks in capital spending. Others, including pharmaceuticals and technology, have to keep spending to maintain technological progress. Yet Amram Shapiro, director of PRTM, insists that capital spending that supports innovation is critical to both types.

“In long-product-life-cycle, capital-intensive industries, where plant capacity is often added at a large scale, whether best-in-class process technology is developed and piloted and ready to scale up determines the economics of the company for many years,” explains Shapiro. “In short-product-life-cycle, R&D-intensive industries, the ability to execute quickly and ramp up to the levels needed is often the secret to success.”

Corning Inc., which has spent the past several years writing down huge investments in fiber-optic technology, now plans to spend $900 million to $1 billion in 2005, mostly on new plants that make liquid crystal display (LCD) screens for flat-panel computer monitors. That figure is two-and-a-half times what it spent in 2004. “We are ramping up our capital spending quite significantly,” says Jim Flaws, CFO of the Corning, New York-based diversified technology company. Flaws points out that Corning isn’t betting on a broad economic recovery to justify its new spending, but rather is seeking to exploit a specific growth opportunity.

Besides Corning, four other companies — biotech firm Amgen, computer hardware manufacturer Dell, automotive and transport parts maker Johnson Controls, and aerospace communications manufacturer L-3 Communications — are spending much more on capex than the average for their industries. Yet those four companies also achieved the highest returns on their expenditures in their respective industries. That suggests that under the right circumstances, companies can increase their capital spending without sacrificing their bottom lines.

Amgen, for example, not only increased its spending during the past four years at an average rate of 46 percent — some 20 times the industry average — but also tops the pharmaceutical industry with a return on gross fixed assets of 80 percent, more than twice the industry’s average. Shapiro says Amgen isn’t the only R&D-oriented company that has been increasing its capital spending. “There are many cases of companies spending large sums in both [R&D and capex],” he says, noting that the challenge is to integrate them. In practice, Shapiro says, that means turning future technology into present technology as efficiently as possible.

Course Correction

Meanwhile, some companies that have cut spending acknowledge that they will have to reverse course soon. Lafarge, for instance, has seen its capital expenditures decline by an average of 13 percent a year since 2000, compared with only 8 percent for others in the construction-materials industry. Part of that reflects a natural downturn after heavier-than-normal spending by the French company in the late 1990s, when its U.S.-based subsidiary began laying out roughly $700 million to build or refurbish several plants in North America, the company’s single biggest market. And Lafarge N.A.’s annual maintenance capital budget requires anywhere from $200 million to $250 million a year in capital spending, about equal to one- half cash flow from operations. Last year, however, the U.S. subsidiary’s capital spending fell below $200 million, which Lafarge N.A. CFO Larry Waisanen says “is probably not sustainable.” The good news, he says, is that the subsidiary expects demand for its products — and its operating cash flow as a consequence — to improve soon, enabling it to boost spending without having to borrow.

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