This Mexican Mule Train is slowly pulling into its destination and it is pretty clear the haul is empty. But at least it highlights a few things. Let’s recap the original thesis before figuring out what we know and where to go from here.
This ill-fated adventure began with the idea we are running out of stuff. Not all stuff, just some stuff. Since many folks supply such stuff, it suggests the scarcity of stuff is due to a market-wide supply problem of said stuff. After hearing all sorts of mania about how industry’s lack of investment since 08/09 leads to skewed cash flow analysis, it seemed reasonable to consider when investment must begin again in order to alleviate said shortage of stuff.
The quick answer is that industry HAS been investing, and in some places quite heavily even through the 08/09 timeframe. This is contrary to naysayers and media and certainly contrary to my prior generic belief after reading such press. You have no idea how much it pisses me off that I was swindled with this generic view. Then again, this is why I do such analyses. But like excessive valuations in one direction or another, incorrect viewpoints can linger longer than expected. Just talk to a contemporary General mentored by a Cold War-era veteran.
Moving on, let’s see if we can hitch on to a different Mexican Mule Train.
1. Capital Intensity by itself is not a leading indicator
This should be clear by this point. The past few posts on the subject highlight the cyclicality in capital intensity and in some cases the already high levels of capital intensity in areas where underinvestment was presumed. In fact, I would now argue that capital intensity is highest in industries where prices are most depressed and players think they can push competitors out of business, but we will leave that for some other time.
2. Capex cycles are linked to business cycles which may be longer than a calendar year
This is a large part of Po Pimp’s point. Well run companies are smarter than Wall Street and have much longer timeframes than demanded by traditional y/y or q/q metrics quoted by the press. If a capex cycle lasts more than a year it won’t be captured by summing FY sales and FY capex. This suggests the need to match capital intensity to the business cycle. As an aside, this represents one of the big reasons buy-side generalists have such trouble with industry specific fundamentals.
3. Higher capital intensity does not mean higher spending for all parts of the chain
Increased capital spending for an industry is not necessarily evenly distributed across all providers. Newer technology is usually built on the back of prior technology. We and TNT love drama and want something revolutionary to change the world, but in the end, incremental technology changes are what moves the world forward. Newer technology carries higher recent costs for a given return and thus leads to higher prices within its segment, driving overall capex higher. This last sentence is a mouthful but represents the reason why capital intensity rises in nearly every case and every industry.
From all of this, the key is to focus on the specific segments driving the increased capital requirements. For example, if you see “capital intensity” rising at telecom companies, it is probably not a good idea to expect that increased capex to flow down to providers of wireline equipment. Seems obvious when put this way, but the generic sell-side capital intensity argument misses this nuance.
When considering capital intensity as a “leading indicator,” look for the incremental technology spending that is driving this capital intensity higher. That is where new investment cases can be found.
