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 Combine a lost decade of investment and some of the easiest debt
terms in a long generation and the costs of delay look like they may
be high.
Just as many argue that the U.S. itself should be borrowing cheap
and long to invest in infrastructure, so it seems that corporate
chieftains should be locking in current easy debt terms and
investing the proceeds.
Nothing lasts forever, including current easy financing conditions,
which could tighten sharply if interest rates rise or if economic
setbacks dampen risk appetite among lenders.
The slow pace of capital expenditure is one of the puzzles of the
long, stuttering semi-recovery from the financial crisis. By almost
all traditional measures, the past several years have been excellent
times for companies to invest in new productive capacity.
Corporate profit margins are near record levels, the average age of
industrial machinery is as old as it's been since the waning days of
the Great Depression and capacity utilization is now approaching
pre-crash levels. All of this implies new investment could be made
profitably, but this is not what is happening.
While non-residential investment is now about where it was during
the pre-crisis period, there is a huge accumulated backlog of unmade
investment since 2007 compared to previous trends. Net capital
expenditure is at the same level as it was in 2000, since when there
have been two huge plunges.
To be sure, to invest would require borrowing, as capex this year is
outpacing internally generated funds for the first time since 2008.
“This means that corporate America is now reliant on external
financing if it wants to merely maintain the current levels of
investment, let alone boost capex further,” Societe Generale
economist Aneta Markowska writes in a note to clients.
“But this is not necessarily a reason for concern. Positive
financing gaps are in fact quite typical, especially in later stages
of the business cycle.”
Indeed, financing markets are wide open, for the highly
credit-worthy and the high-yield borrower alike. Bond yields for
seasoned Aaa-rated bonds, while a bit higher than in 2012, are still
at levels otherwise not seen since 1963, according to Moody’s data.
For Baa borrowers it is a similar story, except you need to go back
to 1958. High-yield borrowers are paying rates that, while not at
pre-crisis levels, are still very attractive compared to most of the
past 15 years.
OPPORTUNITY COSTS
These free and easy financial markets, which are in large part a
creation of central bank policy, won’t last forever. Quantitative
easing will likely cease after the Fed’s October meeting, and
consensus is for modest interest rate hikes beginning next year. If
things play out as most expect, interest rates should rise in
absolute terms and the bid for riskier borrowers should become
weaker.
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And if the Fed is unable to raise rates as expected, financing will
almost certainly get tighter anyway, as this scenario implies a
spluttering economy which might make the risks taken by investors in
recent years look overly bold.
In either of these scenarios financing costs will be higher, and
those with a real need to replace and upgrade capital stock may wish
they had acted earlier.
There are competing theories to explain the unusual decision-making
by companies when it comes to investment.
One school holds that this is essentially the result of an agency
problem, as corporate managers seek not to invest for the long term
but to drive share options into the money in the here and now.
Companies have, after all, been borrowing, but not to invest in
capacity, rather to fund share buybacks. This flatters earnings and
drives up the price of shares, but leaves open the risk that
companies are eating their seed corn and will, at some point when
today’s managers are long gone, find themselves uncompetitive and
under-resourced.
The second theory holds that low investment is the natural result of
the high debts taken on in the past and the trauma of the financial
crisis. Companies are being cautious because they recognize that
their position is less secure and also because they, on the ground,
see evidence to back up the theory that low growth is here for an
extended stay.
All of this could be true, or simply a self-fulfilling prophesy.
Both capital expenditure and financing costs are unusually low, a
situation which is unlikely to last.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be an
owner indirectly as an investor in a fund. You can email him at
jamessaft@jamessaft.com and find more columns at http://blogs.reuters.com/james-saft)
(Editing by James Dalgleish)
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