Despite macro uncertainties, global capital spending continues to surge after a period of short-lived contraction in 2020, powering the post-pandemic economic recovery. The Investment Grade Credit team explains how this might impact market sectors.
04.08.2022 | 07:08 Uhr
Despite macro uncertainties, global capital spending continues to surge after a period of short-lived contraction in 2020, powering the post-pandemic economic recovery.
We expect U.S. Investment Grade Corporate CAPEX to increase +15% in 2022, maintaining the +14% year-over-year (YoY) momentum in 2021 (Display 1). Its impact on fundamental credit profile flows through all three financial statements: CAPEX is a key determinant of cash flow, of multi-year leverage trajectory and debt supply, as well as of future revenue and margins through capturing demand and increasing productivity over time.
We view U.S. Technology as a clear winner, while U.S. Utilities and U.S. Telecom emerge as sectors most under pressure (Display 2).
Global CAPEX Is on the Rise
Source: S&P Global CAPEX Survey 2021. Forecasts/estimates are based on current market conditions, subject to change, and may not necessarily come to pass.
CAPEX Is Impacting Different Sectors in Different Ways
For informational purposes only and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy.
According to the U.S. Census Bureau 2022 Capital Spending Report (Display 3), from 2011 to 2020 U.S. non-farm businesses increased total spending from $1,243.0 billion to $1,706.4 billion, an increase of $463.5 billion (+37.3%). The increase was led by Utilities (+85.8% or $84.2bn), partially offset by the largest decrease in the Mining sector (-41.4% or $68.6bn). Underlying this trend are three driving factors: Sustainability, Supply chain, and Security.
The Three Reasons CAPEX Is Rising: Sustainability, Supply Chain, Security
The broader transition to a more sustainable global economy drives higher CAPEX across industries in order to reduce
carbon emissions, protect water supply and improve the environmental
and social impact of supply chains over the long term. Key themes
include electric vehicles (EV), utility grid upgrades, transition from
fossil fuels to renewables, and overall energy efficiency.
U.S. Census 2022 Capital Spending Report
Source: U.S. Census Bureau 2022 Capital Spending Report
Government policies broadly incentivize and support corporate Environmental, Social and Governance (ESG) initiatives. The ongoing Assessment Reports of the Paris Agreement and Intergovernmental Panel on Climate Change (IPCC) helped to consolidate international support and increase corporate commitments to net zero carbon emissions, with Europe leading the way. Specifically, Europe’s “Fit for 55” package and other efforts have provided tailwinds for green CAPEX by providing command and control mechanisms such as fuel blending mandates, offering clarity in defining sustainable activities (EU Taxonomy), and adopting market-based approaches to implement carbon initiatives, which include carbon markets and border adjustment mechanisms for carbon intensive sectors such as steel, cement, aluminum, and fertilizers.
Estimates on economy-wide investment requirements have an understandable spread, although they clearly exceed current capital expenditures. By 2030, annual global investment requirements to meet net zero goals are anticipated to $4 - $5.7 trillion per year in clean energy and energy infrastructure alone,1 at least three times current levels. Recent research from McKinsey suggests that using the hypothetical Net Zero 2050 scenario from the Network for Greening the Financial System, annual overall green investments needed to stay on track for net zero between now and 2050 are $9.2 trillion ($275 trillion total).
While we may reflexively think of government compelled “green” capital investment as detrimental to corporate balance sheets, the European Union has put in place several mechanisms to protect European corporations from competition by taxing less-sustainable imports. The time bound, science-based goals create immediate investment pressure on both public and private sectors, particularly as the importance of achieving 2030 interim targets becomes increasingly clear. Therefore, we view Europe as a potential bellwether for the U.S. and expect to see even higher green CAPEX levels globally.
Global supply chain is another hot topic—strained in normal times and stressed repeatedly in recent years for a variety of reasons—and U.S. corporates are diversifying manufacturing capabilities in response. They are also increasing efficiency and automation, bolstering productivity to address labor shortages and tight inventories.
Labor inflation is a key leading indicator for manufacturing CAPEX. Under current conditions, we expect to see a cycle of elevated spending to improve profitability. Companies look to automate wherever possible in order to compensate for low labor levels and high wages, however these investments are initiated in sectors where demand outstrips supply and strong cash flows can fund the spending.
In the theme of de-globalization, many industries are onshoring manufacturing capabilities to address shipping bottlenecks in the near-term and increase diversification longer-term. Companies in the Machinery, Electrical and Transportation equipment sectors are seeking to re-shore to reduce lead time and increase flexibility, whilst companies in the Aerospace, Communication, Automotive, Semiconductors, Chemicals, Medical products, Pharma sectors list national security and supply security as the top reason. This trend is broadly aligned with the U.S.’s sustainability goals and the broader economic agenda to boost domestic GDP and create jobs post pandemic.
Geopolitical security has taken on heightened importance in 2022 given the ongoing Russian/Ukraine conflict in Europe. Where it intersects with Sustainability and Supply Chain, we see CAPEX dedicated to address all these concerns take priority. Namely in Agriculture and Energy sectors, along with the push for decarbonization, we see initiatives aimed at bolstering the aggregate level of supply and diversifying away from certain regions. For example, there are discussions for the U.S. and EU to boost supplies of liquefied natural gas (LNG) in European countries by the end of 2022, which would help reduce reliance on Russian gas and incentivize greater LNG diversification. The REPowerEU plan would not only cut Russian gas imports, but also call for an accelerated integration of wind and solar, biomethane production, and heat pump addition. The goal of these plans, in collaboration with international partners, is to chart an alternative path for Europe’s energy security since Russian gas currently accounts for about 40% of total supply.
SECTORS WITH STRONG TAILWINDS: Limited rating migration net of new supply. Benefits from strong government support and increased financial flexibility. We believe current CAPEX investments will directly accrue to higher productivity, better margins and drive future demand with limited impact on credit profile.
SECTORS UNDER PRESSURE: Deterioration in credit profile net of new supply. Incremental CAPEX is a “tax” on free cashflow (FCF) and leverage profile driven by regulation and/or market dynamics. Higher leverage occurs without commensurate growth in future demand and profitability.
SECTORS IN FLUX: Rife with challenges and opportunities, with final outcomes driven by public policy, level of government support, and management teams’ choices in navigating the path forward.
We believe three sectors are particularly sensitive to the future course of public policy in their respective areas.
Another area of focus is the expansion of network grids. This includes greater regional interconnectedness, support for EV charging, and smart grids to improve efficiency for consumers.
SECTORS THAT HAVE HIGH MAINTENANCE CAPEX and could benefit from targeted, long-term solutions that address higher input costs in an inflationary environment.
CAPEX Summary: Credit Profile Winners and Losers
The fundamental impacts of CAPEX tell one piece of the story
When we think about investment allocations by sector, the effect of CAPEX on credit profiles is only one piece of the puzzle, one that must be tied to our fundamental views on valuation. The debate about where spreads are going and what is already priced in at current levels remains the key focus for credit investors. Given elevated CAPEX over a multi-year time frame, we could expect to see increasing debt supply which may push spreads wider.
We offer here a visualization of potential fundamental and technical drivers of spread changes resulting from CAPEX outlook. This is based on survey responses of MSIM Fixed Income research analysts on supply outlook and credit profile trajectory of issuers in our benchmark indices. Display 4 above illustrates the relationship between directional changes in credit profiles against expected CAPEX growth and size each sector on relative scale of future CAPEX.
Other contributors: ANGIE SALAM, Head of U.S. Non- Financial Research; ELENA CIAMPICHETTI; Head of European Non- Financial Research; PATRICK HOLT, Analyst, Research; JACKIE DESIR, Vice President, Research; KERWIN BAILEY, Vice President, Research; MICHAEL DEICH, CFA, Executive Director, Research; MATAS VALA, CFA, Vice President, Research; JEFFREY CHIU, Analyst, Research RAYMOND SINGH, Executive Director, Research; HENRY MASON, Senior Associate, Calvert JUN GOH, Associate, Calvert; SAM RODGIER, Associate, Calvert
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