Is high capex really bad?

[mrEngineer]

I think it is common for value investors to hate high-capex companies. Here are some of the reasons:

1) High capex drains cash. This means lower dividend and higher geared.

2) High capex means more depreciation to come in the following years.

3) Many times, high capex companies requires investors to come up with financing through rights issue or placements or capital increase which dilutes the shareholdings. Alternatively, more debt has too be taken up which value investors hate the most.

However, investors usually forget that the world is evolving and sometimes it is indeed a requirement for plants to engage into capex activities to either i) cope with increasing demand, ii) maintain market share, iii) keep pace with technology. Investors seem to ignore the benefits of the capex would bring to both revenue and the bottomline.

IMO, capex is acceptable if we say that payback period can be less than 3 years and IRR of project is more than 15% or the capex will ultimately lead a strategic footprint like for e.g. building a power station to control electric costs.

Lastly, how many low-capex companies out there who can generate high ROEs consistently for a long time? Even there are, these companies are usually priced extremely high P/E>8. Think about it.

[juno.tay]

I don't think high capex necessarily means that it's bad.

I think the issue here is more of high MAINTENANCE capex is bad i.e. the business requires huge amounts of money just to stay alive. Now that's a no-no to me.

However, if you look at some of the fast growing companies - i.e. Starbucks & Walmart over the past ten years, their capex is extremely high. However, at the same time, they were expanding and growing like mad. So thats more of CAPEX for growth.

So the answer is.. it really depends

[freedom]

the problem with them is that they normally do the capex during the peak instead of the bottom.

[mrEngineer]

the problem with them is that they normally do the capex during the peak instead of the bottom.

This is the usual case. In doom & gloom times, mgmt focus is usually cost savings so to enhance bottom-line. Banks also does not want to lend during gloomy times; low interest plus lack of confidence.

[juno.tay]

the problem with them is that they normally do the capex during the peak instead of the bottom.

well if u think about it it makes sense.

capex during peak period increases because they want to meet demand... so they cant be reducing capex.

during periods of economic glooom.. they tend to cut costs (plus existing infrastructure can meet reduced demand anyway)

if they increase their output even more when demand is so low, its just going to lead to excess capacity & lower prices.

[Musicwhiz]

I've seen many businesses in my life, and most require some form of recurrent capex to ensure their PPE remains updated and in working condition, and that they can stay abreast of the latest technological advances. If this is the case, then it enhances the value of the organization as it can get certifications/awards for their professionalism and cutting-edge equipment; and I think such companies deserve to be lauded for their forward thinking.

Of course, once capex becomes prohibitively high (as a % of revenues), then this begs the question of whether capex is being done solely for the sake of it or for renewal of old machinery. This will depend largely on the industry characteristics and also the competition and how well they themselves keep up with technology.

That said, demand usually rises in an up-cycle in the economy and will result in all players increasing capacity in tandem, usually by increasing production by building factories. A recent example is Midas which is going to build a factory to manufacture (I think, correct me if I am wrong) train carriages using aluminum extrusion. When the industry as a whole is booming, this looks very logical and compelling and shareholders will cheer the capex and bid up the valuations of the company in question.

The problem then is magnified when demand starts to trail off or drop off a cliff (due to a sudden recession or natural disaster, perhaps?), because the new factories will start to sit idle and yet operating and admin expenses continue to be incurred. Worse still, even if the economy stays the same or grows slightly all players may face over-capacity and a huge supply glut and be forced to drop prices (intense price-competition) which will hurt margins. So capex must be viewed from this angle and not solely from the point of view on whether high capex is "good" or "bad".

Of course, some companies are serial acquirors (I need not mention names) and require high capex ALL the time. It is up to the investor to decide if this is good for his pocketbook.....

[freedom]

the problem with them is that they normally do the capex during the peak instead of the bottom.

well if u think about it it makes sense.

capex during peak period increases because they want to meet demand... so they cant be reducing capex.

during periods of economic glooom.. they tend to cut costs (plus existing infrastructure can meet reduced demand anyway)

if they increase their output even more when demand is so low, its just going to lead to excess capacity & lower prices.

I would rather they increase capex steadily rather than heavy capex during the peak at one go then recession hits...

[redcorolla95]

There are different kinds of value investors.

One of them likes to buy shares of companies that are at a discount to their assets.
There is usually something wrong with them.
Some people refer to them as 'deep value'.
e.g. Graham, Schloss, Yeoman, Buffett when younger
The typical stock they hold is the low P/B, P/NTA, the net-net
The idea is to find some assets e.g. property / factory / machines etc that are worth quite a bit, and this was usually the result of some high capex in the past.
They're out of favour because the industry outlook is usually terrible, combined with either some capital allocation mistake (like spending money at a wrong time), poor management, or some fall from grace.

Another kind likes to buy great companies at a good price.
They are usually not dirt-cheap.
Some people call them growth, or 'growth at a reasonable price'
e.g. Buffett when older, Hugh Young, Cheah Cheng Hye
The typical stock they hold is the high cash flow, decent growth, high ROE/ROIC/ROA.
The idea is to find a company that generates plenty of owner earnings' that are growing nicely.
'Owner earnings' or free cash flow, is what the owner is left with after spending money on working capital & capital expenditure (be it growth or maintenance capex).
The average company needs to spend money on working capital & capex just to maintain their facilities, otherwise they will rot. So they will have ROEs that average 12-13%. The great company like the Coca-Colas would have ROEs much higher, this is possible when a relatively small factory investment produces a lot more profit. Great companies are rare, and many people will usually want to buy them, so they will usually not be dirt-cheap.

You will usually not find great companies at a dirt cheap price unless the sky is falling like in April 2009. This happens once every 5-10 years. The rest of the time, we have to make a choice.

So this is the conceptual backdrop.
The more relevant question to ask is not 'is high capex really bad' but 'what kind of value investor am I?'.
Do I prefer great stuff at good price (like a Rolls Royce for a price of a Toyota),
or bad stuff at dirt cheap price (like a Proton for the price of a motorbike)?

[newborn1000]

Capital expenditures is great if it's used to build competitive advantage.........

For eg, biz-ecosystems

Microsoft
Google

Basically, they spent their money wisely..........

Google developed and gives out android OS for free, to widen their own moat
More and more people are using their mobile phones to surf the net, hence the more people they can steer to their search engine.....the better it is for google

It really depends on how the money is being spent.....

[juno.tay]

There are different kinds of value investors.

One of them likes to buy shares of companies that are at a discount to their assets.
There is usually something wrong with them.
Some people refer to them as 'deep value'.
e.g. Graham, Schloss, Yeoman, Buffett when younger
The typical stock they hold is the low P/B, P/NTA, the net-net
The idea is to find some assets e.g. property / factory / machines etc that are worth quite a bit, and this was usually the result of some high capex in the past.
They're out of favour because the industry outlook is usually terrible, combined with either some capital allocation mistake (like spending money at a wrong time), poor management, or some fall from grace.

Another kind likes to buy great companies at a good price.
They are usually not dirt-cheap.
Some people call them growth, or 'growth at a reasonable price'
e.g. Buffett when older, Hugh Young, Cheah Cheng Hye
The typical stock they hold is the high cash flow, decent growth, high ROE/ROIC/ROA.
The idea is to find a company that generates plenty of owner earnings' that are growing nicely.
'Owner earnings' or free cash flow, is what the owner is left with after spending money on working capital & capital expenditure (be it growth or maintenance capex).
The average company needs to spend money on working capital & capex just to maintain their facilities, otherwise they will rot. So they will have ROEs that average 12-13%. The great company like the Coca-Colas would have ROEs much higher, this is possible when a relatively small factory investment produces a lot more profit. Great companies are rare, and many people will usually want to buy them, so they will usually not be dirt-cheap.

You will usually not find great companies at a dirt cheap price unless the sky is falling like in April 2009. This happens once every 5-10 years. The rest of the time, we have to make a choice.

So this is the conceptual backdrop.
The more relevant question to ask is not 'is high capex really bad' but 'what kind of value investor am I?'.
Do I prefer great stuff at good price (like a Rolls Royce for a price of a Toyota),
or bad stuff at dirt cheap price (like a Proton for the price of a motorbike)?

this was a really great post that summed up my thoughts. high capex/low capex is simply part of the equation.