3 ways to profit from a capital spending boom
A little nudge from the economy could unlock billions in investment, and these companies would benefit tremendously.
When the U.S. economy was on the cusp of falling into an abyss in late 2008, companies across the nation collectively decided to cut all unnecessary spending. An uncertain road ahead meant it was time to preserve cash.
Of course, these companies eventually loosened up and, as we've seen in the past four years, have been buying back massive amounts of their own stock while doling out ever-higher dividends.
But there is one area that companies remain quite conservative: capital spending, also known as capital investment or capital expenditures (or capex, for short).
Although capital spending has moved up from the crisis-era lows, it still remains far below typical levels. Analysts at Goldman Sachs, who have studied the spending patterns, see "the U.S. reaching a near 50-year low in private non-residential fixed investment when measured against GDP." These analysts believe it would take a $150 billion increase to bring capital investments back in line with historical norms.
Yet companies know that it takes money to make money. Capital investments in new factories, equipment, software, logistics and other areas sets the stage for higher levels of productivity, enabling companies to boost output without a commensurate rise in headcount.
So why isn't corporate America getting busy? Blame it on the economy and CEO confidence.
Over the past four years, a series of headwinds, from Japan's tsunami disaster and the European crisis to the negative impact of the U.S. government's automatic budget cuts (known as sequestration), have all conspired to keep the economy growing at a sub-par pace.
Companies need to see the economy on a sustainable 2.5% to 3% growth path before they'll have the confidence to make long-term investments in the health of their business. For the current year, economists expect the U.S. GDP to expand around 1.5%. Yet in 2014, that figure should rise to 2.6%, as The Wall Street Journal noted.
Equally important, leading CEOs need to believe the political backdrop will also be benign. The good news: They no longer think Washington will create the headaches it's induced in recent years, as this Washington Post article notes. As Goldman Sachs put it, "As confidence gears higher, then capex should open wider."
Smaller businesses, many of which support a broader supply chain of capital equipment production, noted a hint of small optimism in a recent Wells Fargo/Gallup survey, as this chart indicates.
According to these pollsters, small-business sentiment "improved 9 points since second quarter and 36 points since the fourth quarter of 2012, to a positive 25." That's the highest reading since the third quarter of 2008.
So which companies are likely to most greatly benefit from an eventual rise in capital spending? Firms involved in construction, business process automation and other productivity tools. Here's a short sample, though you should keep an eye out for any companies that have a high level of sensitivity to changes in capital spending levels.
Rockwell Automation (ROK)
This maker of factory automation systems has managed to boost sales less than 10% from fiscal 2008 to fiscal 2012. Yet management hasn't been waiting around for business to improve. In that time, Rockwell has been investing hundreds of millions in its Logix Automation control platform, an open-source software system that enables all components of a production process control system to easily interoperate. Moreover, Rockwell's core strength in manufacturing has now been extended into the fields of energy refineries, mining, and food and beverage production.
The world's largest purveyor of construction cranes (along with a food service division) has surely felt the impact of the global slowdown in construction, as a 2012 base of sales of $3.9 billion was well below the $4.5 billion generated back in 2008. And the fact that sales are expected to rise around 5% in 2013 and 2014 tells you there is no capex boom yet underway.
Still, investors have started to embrace this stock in advance, noting the impressive 30%-plus profit growth that is expected in 2013 and 2014, thanks to solid margin gains. Though analysts anticipate earnings per share (EPS) of $1.65 in 2014, they note that Manitowoc earned around $2.50 a share back in 2007, which took place during the last cycle of high-capex spending. The fact that shares trade at around $20 tells you that further upside lies ahead as rising capital expenditures helps push EPS back up to past peaks.
This company is exposed to a rise in capital spending in a broad variety of industries. Its products include test, measurement and monitoring equipment; water disinfection systems; life sciences lab equipment and sensor and control equipment used in a variety of manufacturing applications.
A series of acquisitions have helped sales nearly double to a recent $18 billion since 2006, although organic growth has been much more muted. The deal spree means that "Danaher now boasts one of the premier defensive growth portfolios in the sector," according to analysts at Citigroup -- who suggest the company now has roughly $7 billion in financial firepower to buy its way into additional attractive niches.
Risks to consider: A pullback in the U.S. economy would have a strong negative impact on both capital spending and the outlook for these companies.
Action to take: The best way to capitalize on the capex theme is to identify how a company's products are being used. If they help clients boost productivity or generally expand their capacity or capabilities, then they are likely to see accelerating demand as the U.S. economy strengthens.
David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.
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