Analysis: Cash-rich companies to take front seat in recovery

By Natsuko Waki

LONDON (BestGrowthStock) – Investors are looking to cash-rich companies to drive global economic recovery with capital investments at a time when governments are tightening their belts.

Peaks and troughs of corporate spending cycles serve as an advance indicator for private sector economic activity.

In past cycles, companies have conducted M&A and capital expenditure — which come near the top of the cycle — almost at the same time, as economic cycles matured.

This time around, there is evidence that companies are likely to spend their excess cash to invest in a more focused, strategic way.

Some have started buying other companies, while many still prefer to use cash to repair balance sheets rather than to expand existing businesses or hire more staff, given the uncertain outlook in advanced economies.

At the same time, those under pressure to deploy cash have already boosted capital expenditure in emerging economies whose rapid growth allows spare capacity to be utilized quickly.

For many investors, companies have just been a little hesitant about embracing a full capex cycle so far, but are still likely to increase capex next year — helping to buoy financial markets.

“Governments were the drivers of growth because both wholesale and corporate sector had taken the back seat. They had to take you out of the recession and started the positive cycle. Now they’re backing off,” said Ashok Shah, chief investment officer of UK-based fund London and Capital.

“You will have a capital spending cycle directed to emerging economies because demand is there. Massive capital spending has already started and accelerating in emerging economies.”

According to Thomson Reuters data, companies globally are hoarding $4.3 trillion in cash and equivalents on the books. Separate Reuters data showed U.S. corporate cash grew 9.4 percent so far this year, on top of a 23 percent expansion last year.

Even in stagnant Japan, says J O Hambro Capital Management, aggregate free cash flow of non-financial companies with market capitalization of more than 1 billion yen ($12 million) stand above 500 billion yen, the fourth highest in the past 34 years.

JOHCM also estimated that 50 percent of listed companies In Japan have net cash on their balance sheets, with many of them preferring to raise dividend at this stage — a reason to buy as the dividend yield there is above that of the S&P 500 index.

“In Japan there’s still excess capacity after what happened in the 1980s. So excess cash is continued to be used in … buybacks, dividend and some M&A,” said Scott McGlashan, JOHCM’s senior fund manager.

“The dividend culture has changed dramatically… There is a really powerful recovery in corporate profits in Japan.”


The initial stage of the corporate spending cycle involves share buybacks and dividend increases, to return money to shareholders.

As corporate confidence increases, firms will buy other companies. The market seems to have reached the M&A stage, with worldwide M&A volume rising 19 percent to above $2 trillion, according to Thomson Reuters data.

At the peak of the cycle comes capital expenditure.

What prevents companies from moving robustly into this stage could be the leverage overhang from the financial crisis.

Credit Suisse estimates G4 (United States, euro zone, Japan and the UK) economies still have $6.2 trillion in excess leverage. This needs to be cleaned up before they add capacity.

Still, a poll of fund managers by Bank of America Merrill Lynch showed 43 percent want companies to return cash to shareholders and 39 percent favor increasing capex. Both outweighed any desire to see further balance sheet repair.

“We are in the intermediate phase between where we are and the start of the new capex cycle,” Patrick Moonen, senior equity strategist at ING Investment Management.

“We expect companies in 2011 increasingly start spending cash. You are moving into that (capex) direction. And it will be one of the more important drivers for the economy and equity markets in 2011.”

Moonen expects capital spending, along with positive earnings growth, valuations and abundant liquidity to drive stock markets higher next year.

He estimates European stocks, measured by the DJ Stoxx 600 index, to rise 16 percent, while U.S. and Japanese markets to rise 8-9 percent.

“Corporate spending is the icing on the cake,” he said.

(Editing by Jane Merriman)

Analysis: Cash-rich companies to take front seat in recovery