Companies increased their capital expenditure budgets in 2022 to increase their footprint, meet greater demand and beat their competitors.
Several companies mentioned increasing their budgets for expenditures during first quarter earnings calls. As of Feb. 7, 191 S&P 500 companies reported large increases in capital expenditures -- an 18% increase year-over-year and a 19% increase compared to the fourth quarter of 2019, according to research data from Bank of America.
Why Companies Are Spending More Money
While there are a number of factors at play on why there is continued growth in capital expenditures this year, one key reason is that companies raised an “unprecedented amount of cash at low rates once the Federal Reserve backstopped the credit markets in 2020,” Thomas Hayes, chairman of Great Hill Capital in New York, told TheStreet.
The cash on balances for companies total $3.8 trillion for the S&P 500, he added.
Another key reason is that with inflation edging upwards during the past couple of quarters, companies are “now incentivized to put that cash to work with an urgency to invest in their business versus eroding in value while sitting idle,” Hayes said.
Consumer confidence has risen since the start of the global pandemic and some people feel more comfortable spending money on discretionary items. The rebound in consumer demand has resulted in companies expanding the number of warehouses, retail stores and data centers in 2022. For example, Starbucks (SBUX) is adding about 2000 new locations globally, Costco (COST) up to 28 new stores and Darden (DRI) up to 40 new restaurants.
UPS reported during its first quarter earnings that it plans to spend 5.4% of its revenue or $5.5 billion on capital expenditures as well continue making its dividend payments of $5.2 billion and conduct share repurchases of $1 billion.
The increase in capex is an encouraging sign that companies are willing to expand or reinvent themselves, Sam Stovalll, chief investment strategist at CFRA, a New York-based investment research company, told TheStreet.
“It is likely a sign that these companies believe that the worst is behind them,” he said. “By committing and reinvesting this money via capex activity, this is a good sign and a good faith effort by the companies to grow the business and improve their position from a competitive position.”
Companies are also striving to get their businesses back into shape after dealing with several challenges, including labor shortages, supply chain bottlenecks and inflation. The increase in spending also means the companies are less concerned about wasting capital on expansions and growth if the economy was not reopening fully, Stovall said.
The increase in capital expenditures and higher profit margins are “encouraging signs,” he said. “Now is the time to inject funds to make themselves more competitive as the economy reopens.”
Expanding and growing a business while interest rates remain low is also a savvy move by companies, Steve Sosnick, chief strategist of Interactive Brokers, a brokerage based in Greenwich, Conn., told TheStreet.
“In general, that is a market plus because companies really don't invest unless they feel good about their prospects,” he said. “It's a good time to do it because the cost of money is very low. If they borrowed money at historically low interest rates, this is sound management. Now is the time to borrow and lock it in.”
Impact to Investors
Investors are typically “smart enough to look past any drag it can cause against current earnings,” Sosnick said.
Companies that are profitable can expand and make themselves more efficient.
“It’s a positive sign that companies feel good about investing in their business,” he said. “Major corporations have done a really remarkable job at continuing to be prosperous during difficult economic times. I have to have some faith that management is spending money wisely.”
While not all these investments will work or turn out to be profitable, companies now have “greater clarity into the post covid environment,” Sosnick said.
Why There Is a Downside
Profit margins could be impacted from the additional spending in capital expenditures, especially in sectors such as energy, Tim Seymour, founder of Seymour Asset Management in New York and portfolio manager of the Amplify Seymour Cannabis ETF (CNBS) told TheStreet.
Capital expenditures in the energy industry are growing as demand continues to increase but also as the generation of free cash flow rises, companies can afford more capex, he said.
“Remember many energy and resources companies have dramatically cut capex over the last five years as balance reparation has been deemed more important,” Seymour said. “For many companies in the industrial sector, bottlenecks from covid have led to increased focus on building out supply chain dynamics.”
One issue that could arise is that CFOs could be less focused on margins over the next three quarters as they are using the headwinds of higher inflation to add back to capex and margins will suffer, he said.
