EQUITIES investors have rightly kept a close eye on company operating costs during the recent period of high inflation.
Now it’s time to pay greater attention to capital expenditure, says Anthony Moran, an analyst with Pendal’s Aussie equities team.
Operating cost inflation refers to increases in the price of goods and services a company needs to operate its business. Higher costs for raw materials, labour, energy and the like can squeeze profit margins.
Capital expenditure inflation refers to rising costs associated with long-term assets like buildings, machinery or technology, which can affect a company’s ability to grow, expand, or modernise.
“We’ve obviously gone through a period of very high inflation and spent time figuring out which stocks can pass that on to their customers through higher prices — and which stocks are exposed to the worst of the cost rises,” Moran says.
“While the market has focused on the operating cost side, it’s time to give more focus to the capital expenditure side. Any company with a fair bit of capital intensity will be exposed to price rises in coming periods.”
Price rises have occurred across the board, from gas turbines and other hard equipment to construction costs, Moran says.
“If you’re a capital-intensive company, capex inflation is going to erode returns, especially if you don’t have pricing power,” he explains.
“If you’re in an industry where there are just a few manufacturers and they all have the same cost base, maybe they can pass through the higher costs.
“But if it’s an industry like steel, which is a globally traded commodity, there is no pricing power.”
Moran highlights ASX-listed BlueScope Steel (ASX: BSL), which is undertaking a $1 billion reline of its blast furnace in Port Kembla, NSW.
It’s also considering increasing capacity in North America and building a coating facility in western Sydney.
Pendal Focus Australian Share Fund
Now rated at the highest level by Lonsec, Morningstar and Zenith
“They are going through a very capital-intensive phase and it’s something BlueScope must be wary of because capex blowouts could eat into the cash flow of the company,” he says.
Other examples of companies needing to maintain a strong focus on capital expenditure inflation include Star Entertainment (ASX: SGR) which is finishing off a multi-billion-dollar development in Brisbane and toll road operator Transurban (ASX: TCL).
“The revenue side of Transurban is very attractive because it rises with the CPI.
“But the company has no incremental pricing power, and it is still building its West Gate Tunnel Project in Melbourne.
“What will catch people out is when there is irregular, bumpy capex – something like replacing a plant every five years when the price of the plant has gone up considerably in that period.”
Anthony Moran is an analyst with over 15 years of experience covering a range of Australian and international sectors. His sector coverage has included Australian Industrials and Energy, Building Materials, Capital Goods, Engineering & Construction, Transport, Telcos, REITs, Utilities and Infrastructure.
He has previously worked as an equity analyst for AllianceBernstein and Macquarie Group, spending a further two years as a management consultant at Port Jackson Partners and two years as an institutional research sales executive with Deutsche Bank.
Anthony is a CFA Charterholder and holds bachelor’s degrees in Commerce and Law from the University of Sydney.
This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current at November 1, 2023. PFSL is the responsible entity and issuer of units in the Pendal Focus Australian Share Fund (Fund) ARSN: 113 232 812. A product disclosure statement (PDS) is available for the Fund and can be obtained by calling 1300 346 821 or visiting www.pendalgroup.com.
The Target Market Determination (TMD) for the Fund is available at www.pendalgroup.com/ddo. You should obtain and consider the PDS and the TMD before deciding whether to acquire, continue to hold or dispose of units in the Fund. An investment in the Fund or any of the funds referred to in this web page is subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of income and principal invested.
This information is for general purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient’s personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation. The information may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date.
While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information. Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance.
Past performance is not a reliable indicator of future performance. Any projections are predictive only and should not be relied upon when making an investment decision or recommendation. Whilst we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections.
For more information, please call Customer Relations on 1300 346 821 8am to 6pm (Sydney time) or visit our website www.pendalgroup.com