Markets: Is Corporate America Starting to Spend?
New York: February 21, 2005
By John R. Stephenson

With consumer debt growing twice as fast as personal income and with the current account deficit weighing heavily on the U.S. dollar, it's comforting to know that corporate America is sitting pretty, with hoards of cash at its disposal. After the stock market bubble burst in 2000, companies started paying down debt and slashing costs. While Washington was busy telling anyone who would listen that the economy was improving, the first two years of this "recovery" saw corporations slashing some 850,000 jobs in an effort to regain profitability.

Corporations, eager to repair their finances after the stock market deflated, concentrated their efforts on refinancing their debt at some of the lowest interest rates in decades. Corporations soon discovered there was someone in India or China who could do your job as well as you - for a whole lot less. Not only that, but the stock market boom left lots of spare capacity in the system, so companies really had very little need to spend money on capital investment. The upshot? Corporate America is sitting on some $2.1 trillion in aggregate cash. The question is: what are they going to do with it?

During 2001-2002, companies focused their efforts on repairing the damage done to their balance sheets and when the situation stabilized (2003-2004) companies then focused their attention on plowing some of that excess cash back to investors in the form of stock buybacks and dividend increases. In 2001, financial reinvestment (dividends and share buybacks) clocked in at 31% of operating cash flow and by 2003, it had soared to 40% of operating cash flow - the highest level in ten years. The tide appears to be shifting again, with companies transitioning to a growth focus and looking to fund their growth through either increased capital expenditures or through mergers and acquisitions (M&A).

Figure 1: Business Savings Soar - Personal Savings Falter

This trend toward increased corporate growth seems apparent with some 71- merger deals representing $130 billion being announced in the first four weeks of 2005. With the corporate balance sheets in good shape, strong cash flows and low interest rates, it seems the perfect time for companies to start making the necessary investments to capitalize on this opportunity to fund some smart growth.

A pick-up in capital spending by companies couldn't come at a better time with the U.S. consumer pretty much tapped out from a non-stop spending spree. With the effect of the Bush tax cuts almost totally dissipated and with corporate discounting having pretty much run its course, the one hope for the U.S. economy would be a revitalized corporate sector that could help pick up the tab once the U.S. consumer finally starts to roll over.

Figure 2: The Cash Assets Ratio - At a Twenty Year High

Source: Goldman Sachs Capital Spending Survey

A study by Goldman Sachs showed that capital spending by businesses is likely to increase by 8% across the board in 2005 with spending in the energy sector and industrial sectors the clear outperforming sectors (+15% spending). Within these sectors, companies such as Schlumberger and Transocean (Energy Services) as well as Emerson, Ingersoll-Rand and General Electric (Industrials) seem poised to benefit the most. Other sectors for investors looking to benefit from an up-tick in capital expenditures are in the areas of communications equipment, electrical component manufacturers and the oilfield services sector.