Finally, a Corporate Capex Pickup?

Read US Equities Perspectives, June edition  Peak Growth, Liquidity and Valuations - What's Next?

Riding the capex upturn

Corporate capex in the US last peaked in 2018/19 as the Trump tax-cut driven investment boom faded. Since then, capex trends have been relatively weak, exacerbated by increased trade uncertainty, and Covid-19. 

However, corporate capex have been on an accelerating path this year, given the strong rebound in corporate profitability – profits have tended to lead capex historically as it gives companies the flexibility to reinvest back into their businesses. Further, bank lending standards are continuing to improve which helps capex decisions.

Core capital goods orders have been climbing rapidly of late, rising 23.5% YoY for the month of April 2021   (Chart 1). The Richmond Fed capex intentions survey hit a record high in May 2021 (Chart 2). With consensus S&P 500 earnings expected to increase 33%/12% in 2021/2022 respectively and we expect the positive capex trend to be supported. 

A good deal of recent increase in capital spending has been driven by supply shortages built up during Covid-19 production shutdowns, with spending now bouncing back in order to meet robust demand and to rebuild depleted inventories (Charts 3 & 4). 

We think this rebalancing process is far from over, given datapoints (e.g. from ISM/Institute for Supply Management) continue to indicate low inventory levels across industry supply chains, with order backlogs continuing to climb.

Other than equipment investment, we expect technology-related capex-spend to be robust as well, driven by the demands of remote work and companies’ desire to digitise/automate processes and boost productivity.  According to a recent sell-side survey, ~60% of companies under coverage have increased the spending as a share of total investment, with 2/3 having plans for further increases over the next 6 months.

Fiscal tailwind

In addition to firm support for private capex, government-led investment spending is also a clear tailwind.  Investment in public infrastructure has declined significantly in the past few decades, with US public investment to GDP ratio near multi decade lows as of 2019. This is set to reverse with the Biden administration likely to approve a substantial infrastructure plan to the tune of ~USD2 trn. In terms of timeline, if the bill fails to get bipartisan support (July 2021), the Democrats will likely use the reconciliation approach to pass the bill, with the process starting from October 2021 at the earliest. 

Overall, the balance of probabilities suggests an above-trend investment spending cycle by US companies.

Corporate capex beneficiaries

We highlight below the various sectors through which we can play this theme:

Homebuilders – look through tougher 2H comparisons

Home builders have corrected of late, which we think offers an interesting tactical opportunity.

We think the correction has been sparked by a combination of:

(i) investor concerns around demand slowing at the margin given moderating housing data

(ii) profit taking following strong but in-line 1Q21 results and robust YTD performance, against tougher YoY comparisons in 2H21

(iii) some market rotation out of cyclicals back into growth stocks. 

What to make of moderating housing data?

Housing data seems to be moderating (new and existing home sales, building permits, mortgage applications), while the sharp home price appreciation over the past 12 months and rising mortgage rates raises the question of affordability.

On housing demand, a recent sell-side channel check - covering 7 medium to large sized private builders with broad regional exposure - pointed to continued robust demand during May to early June 2021. Importantly, most builders spoken to pointed to demand being “very strong” or “robust”, with builders easily selling homes as soon as they are brought to market. In fact, builders continue to limit sales to better manage backlogs, as well as production pace and cost.

Overall, these point to continued strong demand for housing, and to the extent that activity has recently stabilised or moderated, this seems to point more to builders limiting sales/facing production and supply constraints, rather than buyer fatigue or broad consumer weakness.  Reinforcing this point, homebuilders in their recent communication guided for stronger than seasonal 2H21 demand. 

Affordability still reasonable; Housing inventories remain at multi-year lows

Despite the accelerated pace of home price appreciation, affordability is still reasonable on a national level, while homebuilders are also managing their mix to allow for an affordable set of product offerings.

Though mortgage rates have risen since the end of last year, they are still standing at 20 year lows (Chart 5).

Specifically, at current mortgage rates, the NAR’s (National Association of Realtors) Composite and First-time Buyer affordability indices are roughly flat YoY; remain >10% above 2H18 levels, and are much higher than their 1995-2004 averages (Charts 6 & 7). 

Also, the national home price-to-income ratio, using 1Q21 home prices and 4Q20 medium incomes, is 5% below long term average.

Inventory is another key driver of housing market trends. We see little risk of housing oversupply, given housing inventory levels on average is down 25% YoY, as of April 2021, with existing home inventory levels near 20 year lows.

Remain positive on homebuilders

In all, we remain positive on homebuilders. We expect demand backdrop to remain solid, supported by still-low interest rate environment, as well as the industry’s positive demand/supply dynamics led by tight inventory levels. This should translate into above normalised level of growth for some time. Falling lumber costs may also ease cost pressure from building materials. 

While there will be an unavoidable slowdown in order trends against tough 2H21 comparable, we believe getting through this period will ultimately be a positive catalyst.

Internet – robust fundamentals for advertising (ad) driven names

Within the internet sector, we see better near term opportunities within ad driven names. As the economic recovery continues to play out, 1Q21 digital ad results and forward commentary came in much stronger than expected, as retailer and ecommerce ad spend continues to surge and as branded ad market returns.  Advertising being a cyclical industry, we see faster GDP growth leading to more ad spend across more industries, as companies spend to reach the recovering/re-opening consumer (chart 8). 

Structurally, we expect advertising to continue to shift online, given the growing importance of performance/ROI driven ad spending, and the fact that the nature of online advertising is mostly performance driven.

1Q21 ecommerce ad trends were better than expected, not only because of higher online retail penetration, but also because retailers’ ad budgets are moving online faster as omni-channel has become more important, and as leading online advertising platforms’ commerce innovation/solutions continue to accelerate (chart 9).

The overall industry setup is positive for leading digital advertising and social media platforms. Within this group we favor the mega-cap names on strong business momentum, reasonable valuations and optionality around under-monetized assets.  We also think some mid-cap names with strong user growth and user engagement are very interesting from a structural growth angle, given a long runway for monetisation, though we expect tactical volatility around valuations. 

CONCLUSION/STRATEGY 

We expect an above-trend investment spending cycle by US companies, and would view short term corrections in capex-themed names as opportunities. Homebuilders in particular look tactically interesting as we expect a multi-year upcycle underpinned by positive demand/supply dynamics. Within the internet space, social media/advertising-driven names will likely see stronger momentum as they benefit from cyclical upturn in ad spending.