Yesterday, one of my blog readers commented on one of my posts. He asked a question on capital expenditure. I really need to thank him for asking such a question as it allowed me to reinforce my value investing knowledge. I would post the question by the reader and also my reply below. Why I’m doing this is to open this up for discussion and to allow seasoned value investors to comment on this for all to learn and improve ourselves in this journey (hopefully, they give their two cents). Here goes:
Thanks for the explanation.
However, I disagree with the understanding that capex should be as low as possible. Capex or “cash flows from investing activities” should be at a reasonable level for a growth company. A good company is one that has a significant level of growth and for that to happen, they must invest for growth. So high capex does not necessary mean that the company is bad. In fact, I would be happy for a coy to put in 70% of earnings into capex as long as it reaps returns in the next few years.
Just like the TMC analysis, if TMC consistently have very low capex, then I know for sure they’re not serious about expanding overseas. And it’s not a company I will be interested in investing in. If they were to build a hospital in china for example, their capex will soar and to me, that’s a good sign. I hope you get what I mean. Cheers.
Firstly, capex is not equal to cash flow from investing activities. Capex is only part of cash flow from investing activities in accounting terms.
Secondly, capex means capital expenditure in full. It means “funds used by a company to acquire or upgrade physical assets such as property, industrial buildings or equipment. This type of outlay is made by companies to maintain or increase the scope of their operations. These expenditures can include everything from repairing a roof to building a brand new factory.” (courtesy of Investopedia). As you can see from the definition, it includes things that does not promote company growth like repairing a roof, etc. Yes, it includes purchasing of factories which may be needed to increase production for growth for manufacturing companies but does it ALWAYS promote growth? To answer that, you need to look at other metrics as discussed below.
Next, I agree with your statement “A good company is one that has a significant level of growth and for that to happen, they must invest for growth.” To see if a company is re-investing into its own business for growth, you don’t look at capex but look at “Retained Earnings” under the Balance Sheet. You can also calculate its ROE and CROIC (Cash Return On Invested Capital) to see if a company is re-investing in itself.
Do you think Coca-Cola is a good company? I certainly think so from their financial statements and also by how famous their drinks are. Did u know that Coca-Cola has extremely low capex? Their capex amounted to only US$1.5 mil on average over the last 5 years (I can only quote 5 years data as that’s what I got from the net. It was much lesser historically). Their revenue for FY2009 was around US$31 mil. Their capex was only 4.8% of total revenue. Their capex is very low as they have outsourced their bottling enterprise which is capital intensive (high capex). Coca-Cola’s stock price is up 3602.58% every since listing. In the long run, rise in stock price is equal to rise in value of company. Coca-Cola certainly has grown tremendously even with low capex.
Low capex and high operating cash flow gives u lots of free cash flow. Free cash flow is what is essential for a company to grow and pay dividends and not high capex. This is the reason Warren Buffett shuns companies with high capex. Capex should not be seen as a figure alone but with revenue. For example, airline companies don’t do well in the long run due to high capex to maintain their aircraft fleet. SIA replaces its planes every six years on average. When money is tied up to buy new planes, how can the company re-invest to generate more growth? This is just one example. There are many such examples I can quote. I’m lazy to type all those in and I’m sure you will get bored reading those examples.
Now, let’s come to TMC. I’m afraid to say you are wrong when you say TMC “not serious about expanding overseas”? Do you know that they are going to have a hospital in Vietnam launching soon and a second one in the pipeline with such low capex? They have chosen Vietnam as Vietnam is an untapped market with huge potential. Vietnam has a birth rate of 17.73 births/1,000 population vs Singapore’s 8.82 births/1,000 population. Also, the hospital in Vietnam is located in one of the most affluent parts of Vietnam. Now, tell me if they serious in the growth of their business?
I sincerely hope I have answered your question.