Preparing for a capex spree

Rather than declining, capital expenditure in mining and other industries is set to surge in 2014.

Summary: The mining boom is far from over, if capital spending estimates are anything to go by, adding further proof that the economy is rebounding. Across the mining sector, investment spending will top $110 billion in 2014, and investment spending in other sectors will exceed $60 billion.
Key take-out: Improved confidence levels across the economy will flow through to greater business investment.
Key beneficiaries: General investors. Category: Growth.

Eureka Report managing editor James Kirby, in his latest EurekaTV report video, asks the question: Where will the market go from here? Well, it may not seem like it, but the dataflow we saw last week was pivotal in answering that question.

Recall the central domestic economic debate hinges upon two key premises. Firstly, that the mining boom, well the investment boom, is over; and secondly, that there is little in the way of a replacement for this boom now that it has passed. The follow through is that growth in Australia would be sub-trend through to 2014. Softer aggregate demand would then hit corporate profits, and earnings forecasts would continue to fall, which, of course, would mean that our market was expensive. Plenty of equity strategists are out and about claiming that earnings to date have been driven primarily by cost cutting and, while that is true in some cases, it’s not generally true.

Anyway, the bigger point and why investors need not fear – is that last week we found out that the foundations upon which these views all rest are false. How good is that! Recall that I first wrote about this last year in two pieces: Heading into a 2013 boom and Busting the bust myth, but I can now state to readers with much more confidence that the view I first outlined in those pieces looks to be unfolding – even quicker than what I had thought..

The first thing to note is we now know that mining investment isn’t expected to peak this year – which is the Reserve Bank of Australia and the consensus view. Actual mining companies are telling us something different, and this is critical.

I can see why there is confusion though. Take a look at chart 1 below.

It shows that from the first estimate of capital expenditure in 2012-13 (made in January-February last year) to the latest estimate, there has been a sizeable downward revision in estimates of about 25% or so, from $120 billion to about $92 billion. So, initially, miners were saying investment was going to increase 46% this year, but now they are saying it’ll increase by about 13%. A casual glance would suggest there’d been a material reassessment and that the investment boom was indeed winding down.

But take a look at chart 2. This shows the first estimate of capital expenditure in 2013-14 (the red column). This chart really puts the nail in the coffin for the end of the mining boom view.

The way I see it, it simply doesn’t make any sense to think downgrades through 2012-13 represent a material reassessment of investment, when investment is then expected to surge again in 2014. If there had been a material reassessment, then investment wouldn’t be increasing again in 2014 – and by such a large magnitude.  And, I‘ll be honest I am surprised by those numbers. I would have thought they would show a modest fall, or at best flat growth relative to 2012-13, which is what you would need to see to argue that the mining boom was over or had plateaued. But no.

Chart 2 shows quite clearly that miners don’t expect investment to peak this year – as the consensus does. There is no plateau that we can see – because investment is forecast to rise another 14% next year (using five-year realisation ratios). Beyond that, we simply don’t know. Any talk of an end or a plateau is, and can only ever be, unusable speculation for a serious investor. In any case, and as I highlighted in previous pieces, there is such an enormous amount of work in the pipeline, hundreds of billions, that any talk of a peak this year never made any sense.

What is happening outside of mining? Well, manufacturing investment is tumbling, but this reflects a broader malaise for the industry – a lack of leadership, a reliance on corporate welfare and a weak entrepreneurial culture. Thankfully it’s only 10% of the economy and even less relevant for national investment.

Anyway, I digress, as outside of that sector investment is expected to surge, which is the blossoming of that boom I talked about last year. It’s fantastic. Recall that, in my research last year, I showed that non-mining companies were barely investing to cover depreciation. Non-mining investment was at its lowest since the 1990s recession, which is odd given our growth metrics and global growth more broadly. Given the outlook!

This looks to be changing. Check out chart 3. It shows expected investment in 2013-14 for ‘other sectors’. Investment here is about six times that of the manufacturing sector it should be noted, so it’s important.

The red column shows investment intentions for ‘other’ sectors (finance, telecoms, utilities, retail and wholesale trade among others) in the year to June 2014. It shows, after an expected dip this year, a 12% increase in intentions is expected in 2014. If realised this would be the strongest gain in about eight years.

Now pessimists may retort that this is only expected investment and actual investment may be revised lower. It might, but they need to make a case as to why it might and provide some evidence. It might also be revised higher and, on balance, this is much more likely. Why?

  • Because non-mining investment is the lowest it has been relative to GDP in decades.
  • Moreover, these investment intentions reflect what firms planned to do in December. While the survey was conducted in January and February, the practical reality (holidays, staff leave) is that this isn’t sufficient time to reflect on the significant change in economic sentiment since December. The jump in confidence etc. So the survey may have been conducted in January and February, but the answers reflect what firms were thinking in December. Consider that global markets have pushed much higher – the All Ords is about 9% higher over the first quarter alone.’ We didn’t go over the fiscal cliff and everything else.

The bottom line is that spirits are much higher now, and that usually leads to greater business investment – especially from these lows.