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article imageU.S. companies ramp up capex as confidence grows

    Feb 20, 2014 in Business

By Caroline Valetkevitch

NEW YORK (Reuters) - Earlier this month, Eaton Corp Plc <ETN.N> made an announcement that captured little attention: the diversified manufacturer of heavy truck transmissions and residential circuit breakers said it would spend a record $700 million this year on tooling and machinery.

Eaton is not alone. The biggest U.S. companies are poised to surprise investors this year with how much they are planning to dig into their massive cash stock piles and invest in big projects.

Corporate America has been reluctant to spend aggressively since the recession, choosing instead to amass cash reserves or reward shareholders by raising dividends and buying back shares. Cash still represents close to 10 percent of the market value of members of the Standard & Poor's 500 index <.SPX>, though that is down from the 11.5 percent peak seen early in the economic recovery, according to S&P Dow Jones Indices data.

"A lot of companies got caught cash short in the downturn, so they have been reluctant to spend the cash they've reliquified their balance sheets with. Now they're starting to see a pickup in the economy, and they're starting to loosen the purse strings," said Jeffrey Saut, chief investment strategist at Raymond James Financial in St. Petersburg, Florida.

According to a Thomson Reuters analysis, 70 percent of the 227 S&P companies that have so far announced 2014 spending plans have exceeded Wall Street's expectations. That is the highest level in at least five years and suggests executives have greater confidence in their growth outlook.

The average capital expenditure for the year is about $1.71 billion, according to the Thomson Reuters data. While that is up only a modest 2 percent from last year's $1.68 billion, analysts on average had been predicting spending to fall nearly 4 percent from 2013.

Behind the increased corporate optimism, strategists say, is receding concerns about the U.S. fiscal budget, an improving outlook from the euro zone, and a need by companies to make sure their production capacity keeps up with rising demand.

U.S. companies are currently using roughly 78.5 percent of their production capacity, Federal Reserve data showed. That's near the highest levels since the recession and up substantially from June 2009's record low of under 70 percent.

"We're approaching 80 percent (on capacity utilization) and that's usually the mark where they're starting to feel some pressures to add a little bit more capacity into the equation," said Russell Price, senior economist at Ameriprise Financial Services in Troy, Michigan.

In the case of Eaton, which derives around half of its sales from the U.S. market, the 14 percent increase in expected capex this year might seem aggressive. Still, the company said the outlay is in keeping with its average capex budget of around 3 percent of sales. That means the forecast is driven more by an improving sales outlook than by a sudden desire to spend big on the business.

Other companies eyeing substantial capex increases include industrial conglomerate United Technologies Corp <UTX.N>, which plans to spend $2 billion on plant and equipment this year, up nearly 18 percent from 2013; miner Freeport-McMoran <FCX.N>, which plans to spend $7 billion, up 32 pct from 2013; and railroad operator Union Pacific Corp <UNP.N>, which expects to spend $3.9 billion, up about 12 percent from last year.


The S&P 500 rose 30 percent in 2013 and analysts said U.S. stocks could extend their rally this year as the projected increase in corporate spending translates into more demand and a healthier economy.

"Revenue growth is going to be helped by companies investing and spending more, and driving the overall top line of this economy," said Steven Rees, U.S. head of equity strategy at J.P. Morgan Private Bank in New York.

Fourth-quarter revenue growth was up just 1.0 percent from a year ago, Thomson Reuters data showed. Any improvement from a capex tailwind could help cushion some investors' concerns about equity valuations, which are at their highest since 2008. The S&P 500's forward four-quarter price-to-earnings ratio is now at 15.3, compared with 13.1 at the start of 2013, according to Thomson Reuters data.

Corporate spending has been steadily, albeit modestly, increasing over the past few years. Fourth-quarter capital expenditures are seen at $163.09 billion, 10 percent above the third quarter of 2013, according to S&P estimates. That would top the record from the fourth-quarter of 2012, when capex was at $156.28 billion.

Meanwhile, with year-end cash levels among S&P 500 non-financial companies up for eight straight years and approaching $1.3 trillion at the end of 2013, some investors have become increasingly unhappy with companies that hoard their dollars rather than invest in the business or give a good chunk back to shareholders.

One of the most high-profile examples of that is activist investor Carl Icahn's agitation at Apple Inc <AAPL.O>. The company recently said it had repurchased $14 billion of its stock in a two-week period.

Combining dividend payments with buy backs, S&P 500 companies spent an estimated $214.4 billion returning cash to shareholders last year, around 31 percent more than their capex outlay. Still that's substantially below the 40 percent gap between them the year before.

Companies "have been handsomely rewarded by financial markets for doing buy backs and increasing dividends rather than investing in their business," said Michael O'Rourke, chief market strategist at JonesTrading in Greenwich, Connecticut. "I don't expect this behavior to change."

The bulk of capex in recent years has come from the energy sector, which is expected to continue to be a big spender on capital projects. Energy accounted for 25 percent of S&P 500 capex and research and development spending in 2012, according to Goldman Sachs.

"Energy has probably been the standout in terms of companies deploying capex," said Eric Marshall, director of research at Hodges Capital Management in Dallas, Texas. "But you're starting to see that spread now into the broader market."

(Reporting by Caroline Valetkevitch; Additional reporting by Lewis Krauskopf; Editing by Dan Burns and Tiffany Wu)

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