“Overall, declining Net/Gross PP&E levels signal continued subdued growth for the U.S., but pockets of opportunity remain”
Valens Research would like to share with you our Litman Letter for July 2016, which looks at the relationship between “net to gross” property, plant, and equipment (PP&E) levels, an important indicator of management’s keenness or reluctance to invest in their asset base.
This Litman Letter, a monthly newsletter written by our Chief Investment Strategist Joel Litman, discusses how the net-to-gross ratio of PP&E levels has fallen to the lowest level measured in the S&P 1500 in 15 or more years, an indication of how firms are prioritizing asset efficiency over maintenance capex outlays and new investments.
In the file linked below, you will find a study of the net-to-gross PP&E levels of the S&P 1500, and how these levels indicate that management teams continue to be wary of investing in growth, even in the low interest rate environment.
Hope you find the article interesting.
Valens' equity and credit research relies on a bedrock of deep fundamental forensic analysis with a coverage of over 4,000 equities and all major corporate credit. That means “cross-capital” equities and credit research are not siloed, but instead are fundamentally aggregated and compared with orthogonal data points.
To access all our previous Litman Letters, click here: http://hvst.co/2cKmogHProfessor Joel Litman
Chief Investment Strategist
joel.litman@valens
-
securities.com
The Litman Letter
July 2016
“Net/Gross
PP&E”
levels
are
yet
another
indicator
that
U
.
S
.
firms
are
reluctant
to
invest
.
This
forestalls
any
growth
cycle
and
contributes
to
market
multiples
remaining
at
20
x
to
22
x
Value
-
to
-
Earnings
ratio
and
thereby
a
sideways
to
slightly
upward
S&P
1500
•
The
“net
to
gross”
ratio
of
property,
plant,
and
equipment
(PP&E)
levels
have
fallen
to
the
lowest
level
measured
in
the
S&P
1500
in
15
or
more
years
.
Firms
are
prioritizing
asset
efficiency
over
maintenance
capex
outlays
and
new
investments
•
Overall,
the
only
sector
trending
upward
in
terms
of
growth
in
reinvestment
and
capex
spending
is
the
Utilities
sector,
as
firms
have
had
to
reinvest
into
renewable
technology
and
natural
gas
assets
•
The
Tech
sector
has
shown
a
slight
rebound
in
Net/Gross
PP&E
levels
since
dramatically
falling
following
the
burst
of
the
internet
bubble,
but
remain
well
below
highs
•
Energy
companies
show
a
material
decline
in
Net/Gross
PP&E
levels,
as
many
have
had
to
redirect
cash
flows
toward
servicing
obligations
.
With
the
current
oil
and
gas
price
environment,
this
is
unlikely
to
change
soon
•
Industrial
firms
have
also
seen
declines
in
Net/Gross
PP&E
levels,
as
a
focus
on
improving
returns
to
shareholders
has
taken
hold
•
Management
teams
continue
to
be
wary
of
investing
in
growth,
even
in
the
low
interest
rate
environment
•
Incremental
interest
rate
hikes
could
actually
spur
more
aggressive
investments
if
management
fears
missing
out
on
cheap
financing
for
projects
•
Until
that
happens,
the
U
.
S
.
stock
market
appears
fairly
valued
with
muted
business
growth
holding
back
any
significant
rise
in
market
-
wide
earnings
multiples
•
For more on market valuations, see our Market Phase
Cycle report for June 2016
Valens Securities
425 Fifth Avenue, Suite 21D
New York, New York 10016
+1 (646) 491
-
2601
The Litman Letter
July 2016
Page
2
The
ratio
of
Net
PP&E
to
Gross
PP&E
(property,
plant,
and
equipment)
is
a
useful
metric
to
use
to
understand
when
companies
have
been
“milking”
their
balance
sheets
or
ramping
up
investment
in
the
face
of
expected
growth
opportunities
.
When
Net/Gross
PP&E
ratios
dramatically
rise
(as
they
did
in
2005
-
2007
),
it
means
that
management
teams
are
aggressively
investing
in
their
assets
to
drive
growth
.
When
Net/Gross
PP&E
levels
fall,
management
teams
are
instead
deferring
maintenance
capex
and
managing
for
higher
free
cash
flows
in
the
near
term
.
Prior
to
recent
declines,
the
aggregate
Net/Gross
PP&E
of
all
S&P
1500
constituents
bottomed
out
at
56
.
8
%
in
2010
,
with
companies
beginning
to
spend
on
necessary
maintenance
capex
after
multiple
years
of
attempts
to
save
in
the
wake
of
the
Great
Recession
.
Firms
then
appeared
to
have
rebuilt
Net/Gross
PP&E
levels
to
more
normal
levels
until
the
middle
of
2013
,
when
companies
again
began
to
reduce
maintenance
capital
spend,
eventually
leading
Net/Gross
PP&E
levels
to
lows
not
seen
since
before
2001
.
Net/Gross
PP&E
has
experienced
a
series
of
declines
in
2015
.
It
is
now
at
its
lowest
level
this
millennium,
a
further
sign
that
management
teams
are
not
committed
to
investing
in
business
growth,
particularly
in
energy,
healthcare,
information
technology
and
industrials
markets
.
55%
56%
56%
57%
57%
58%
58%
59%
59%
Q3 2001
Q1 2002
Q3 2002
Q1 2003
Q3 2003
Q1 2004
Q3 2004
Q1 2005
Q3 2005
Q1 2006
Q3 2006
Q1 2007
Q3 2007
Q1 2008
Q3 2008
Q1 2009
Q3 2009
Q1 2010
Q3 2010
Q1 2011
Q3 2011
Q1 2012
Q3 2012
Q1 2013
Q3 2013
Q1 2014
Q3 2014
Q1 2015
Q3 2015
Gross PP&E
-
Weighte d Aggregate Net PP&E to Gross PP&E
Data Coverage: Quarterly from Sep
-
2001 to Dec
-
2015
All S&P 1500 constituents, weighted by Gross PP&E
Source: Va lens Securities Analysis
Information Technology
The
Information
Technology
sector
has
seen
steady
declines
in
the
Net/Gross
PP&E
ratio
since
the
bursting
of
the
tech
bubble
in
2001
.
Companies
began
to
reinvest
in
growth
right
before
the
Great
Recession,
but
have
mostly
managed
their
cash
flows
while
spending
on
capex
only
to
maintain
their
asset
base
after
the
crash
.
Additionally,
tech
firms
have
systematically
underestimated
the
life
of
their
assets,
leading
to
lower
Net/Gross
PP&E
levels
than
other
sectors,
as
these
firms
are
still
carrying
assets
with
zero
value
on
their
books
.
This
is
partly
due
to
the
fact
that
asset
lives
have
been
lengthening,
as
the
effects
of
Moore’s
Law
have
been
diminishing
.
Firms’
investments
are
also
becoming
obsolete
at
a
slower
pace
than
they
have
historically
.
Nonetheless,
Net/Gross
PP&E
levels
have
slowly
increased
since
2003
-
2004
,
and
are
near
highs
since
then,
as
firms
have
begun
to
reinvest
into
their
asset
base
to
replace
assets
that
are
becoming
obsolete
.
Firms
in
the
semiconductor
and
communications
equipment
industries
have
best
exemplified
this,
with
substantial
declines
in
Net/Gross
ratios
between
2001
and
2004
following
the
internet
bubble
.
Neither
industry
has
seen
Net/Gross
PP&E
levels
improve
back
toward
historical
highs,
as
companies
have
been
reluctant
to
reinvest
material
amounts
of
cash
flows
into
their
asset
base
.
AMAT,
INTC,
and
LLTC
exemplify
this
best,
and
JNPR
in
particular
has
seen
Net/Gross
levels
fall
from
+
80
%
to
recent
lows
below
50
%
,
as
they
have
invested
less
in
maintaining
their
PP&E
base,
and
more
in
building
their
working
capital
levels
over
the
last
several
years
instead
.
The Litman Letter
July 2016
Page
3
40%
41%
42%
43%
44%
45%
46%
47%
48%
49%
50%
51%
Q1 2001
Q3 2001
Q1 2002
Q3 2002
Q1 2003
Q3 2003
Q1 2004
Q3 2004
Q1 2005
Q3 2005
Q1 2006
Q3 2006
Q1 2007
Q3 2007
Q1 2008
Q3 2008
Q1 2009
Q3 2009
Q1 2010
Q3 2010
Q1 2011
Q3 2011
Q1 2012
Q3 2012
Q1 2013
Q3 2013
Q1 2014
Q3 2014
Q1 2015
Q3 2015
Information Technology Aggregate Net PP&E to Gross PP&E
Data Coverage: Quarterly from Sep
-
2001 to Dec
-
2015
Info. Tech. S&P 1500 constituents, weighted by Gross PP&E
Source: Valens Securities
Industrials
Industrial
companies
have
been
managing
cash
flows
and
deferring
maintenance
capex
since
2001
,
with
their
gross
to
net
PP&E
ratios
consistently
compressing
.
Barring
a
period
of
reinvestment
leading
up
to
the
Great
Recession,
industrial
firms
have
been
managing
their
cash
flows
to
maximize
their
profitability
.
Furthermore,
as
the
world
moves
away
from
a
reliance
on
heavy
industry,
these
firms
have
a
reduced
need
to
continually
reinvest
in
new
assets
.
Therefore,
consistent
with
management’s
fiduciary
duty
to
shareholders,
companies
have
been
deferring
spending
on
maintenance
capex
to
enhance
profitability
in
an
attempt
to
boost
share
price
.
Moreover,
with
continued
concerns
about
the
health
of
the
economy
post
-
Great
Recession,
industrial
firms
have
also
been
shying
away
from
reinvestment,
even
in
the
current
low
interest
rate
environment
.
Dover
Corporation
is
a
good
example
of
an
Industrials
company
that
has
been
deferring
reinvestment
and
capex
to
maintain
their
profitability
.
They
have
attempted
to
efficiently
manage
their
cash
flows
and
put
off
growth
to
continue
paying
their
robust
dividend
.
This
has
been
difficult
as
the
firm
faced
headwinds
to
profitability
after
the
tech
bubble
burst
due
to
their
tech
exposure,
and
again
recently
due
to
energy
price
headwinds
.
However,
due
to
rising
energy
prices
prior
to
the
housing
market
crisis
in
2008
,
and
once
again
in
2013
,
they
began
to
reinvest
in
their
energy
business
.
Unfortunately,
the
resulting
compression
in
oil
prices
and
their
fluid
business’s
exposure
to
China
has
relegated
the
firm
to
prioritize
their
dividend
over
their
aging
asset
base
.
The Litman Letter
July 2016
Page
4
52%
53%
54%
55%
56%
57%
58%
59%
60%
Q1 2001
Q3 2001
Q1 2002
Q3 2002
Q1 2003
Q3 2003
Q1 2004
Q3 2004
Q1 2005
Q3 2005
Q1 2006
Q3 2006
Q1 2007
Q3 2007
Q1 2008
Q3 2008
Q1 2009
Q3 2009
Q1 2010
Q3 2010
Q1 2011
Q3 2011
Q1 2012
Q3 2012
Q1 2013
Q3 2013
Q1 2014
Q3 2014
Q1 2015
Q3 2015
Industrials Aggregate Net PP&E to Gross PP&E
Data Coverage: Quarterly from Sep
-
2001 to Dec
-
2015
Industrials S&P 1500 constituents, weighted by Gross PP&E
Source: Valens Securities
Energy
Energy
companies
saw
Net/Gross
PP&E
levels
increase
consistently
going
into
2008
,
as
improving
prices
led
to
increased
investment
in
firms’
asset
bases,
and
a
number
of
new
companies
coming
into
the
market
to
take
advantage
of
bloated
valuations
.
However,
since
2009
,
ratios
have
come
down
again,
and
Net/Gross
PP&E
levels
have
substantially
fallen
since
2015
.
This
has
also
been
driven
by
prices,
as
firms
have
had
to
reduce
or
completely
stop
investment
into
their
asset
base
to
keep
up
with
oil
prices
that
have
fallen
from
+
70
%
highs
.
Continued
suppression
in
price
implies
that
even
if
firms
should
be
reinvesting
soon,
it
may
not
be
economically
possible
for
them
to
do
so,
leading
to
a
continuation
of
this
trend
.
This
trend
in
Net/Gross
PP&E
levels
has
also
been
driven
by
some
of
the
firms’
credit
concerns
driving
their
inability
to
invest
materially
in
their
asset
base
.
Chesapeake
is
a
good
example,
with
their
current
credit
issues
well
known
to
the
public
and
to
investors
.
As
such,
they
have
focused
on
cutting
costs
and
focusing
on
sustaining
cash
flows
to
service
their
obligations,
not
including
maintenance
capex
.
This
has
led
to
material
declines
in
their
Net/Gross
PP&E
ratio,
from
+
60
%
in
as
recent
as
Q
1
2014
,
to
current
43
%
levels
.
The Litman Letter
July 2016
Page
5
50%
51%
52%
53%
54%
55%
56%
57%
58%
59%
60%
61%
62%
63%
64%
Q1 2001
Q3 2001
Q1 2002
Q3 2002
Q1 2003
Q3 2003
Q1 2004
Q3 2004
Q1 2005
Q3 2005
Q1 2006
Q3 2006
Q1 2007
Q3 2007
Q1 2008
Q3 2008
Q1 2009
Q3 2009
Q1 2010
Q3 2010
Q1 2011
Q3 2011
Q1 2012
Q3 2012
Q1 2013
Q3 2013
Q1 2014
Q3 2014
Q1 2015
Q3 2015
Energy Aggregate Net PP&E to Gross PP&E
Data Coverage: Quarterly from Sep
-
2001 to Dec
-
2015
Energy S&P 1500 constituents, weighted by Gross PP&E
Source: Valens Securities
Utilities
Utilities
firms
have
actually
seen
substantial
Net/Gross
PP&E
increase
over
the
past
15
years,
in
contrast
to
other
sectors
and
the
market
overall
.
This
growth
has
been
driven
by
material
investment
in
electric
and
multi
-
utility
firms
who
have
been
investing
in
building
out
their
renewable
energy
footprint
.
Furthermore,
the
U
.
S
.
has
seen
large
increases
in
proven
reserves
of
natural
gas
since
2000
due
to
the
development
of
shale
gas
extraction
techniques
such
as
fracking
.
As
such,
previously
uneconomical
shale
gas
is
now
accessible
in
large
quantities
.
Natural
gas
has
since
become
the
top
source
of
electric
power
in
the
U
.
S
.
,
partly
due
to
sustained
low
natural
gas
prices
.
Natural
gas
also
burns
much
cleaner
than
coal,
with
less
greenhouse
gas
emissions,
suggesting
that
natural
gas
can
serve
as
a
bridge
to
renewable
energy
going
forward
.
As
a
result,
companies
have
been
actively
reinvesting
in
new
assets
which
use
natural
gas
as
fuel
rather
than
coal
.
Firms
such
as
Pacific
Gas
and
Electric
(PCG),
which
operates
in
California,
have
been
under
regulatory
pressure
to
meet
renewable
energy
targets,
causing
them
to
substantially
invest
into
their
asset
base
.
Moreover,
with
29
states
actively
adopting
renewable
portfolio
standards
mandating
that
utility
companies
sell
a
specified
percentage
or
amount
of
renewable
energy,
firms
across
the
U
.
S
.
have
been
investing
in
renewable
assets
to
meet
these
new
requirements
.
The Litman Letter
July 2016
Page
6
55%
56%
57%
58%
59%
60%
61%
62%
63%
64%
65%
66%
67%
68%
69%
70%
71%
Q1 2001
Q3 2001
Q1 2002
Q3 2002
Q1 2003
Q3 2003
Q1 2004
Q3 2004
Q1 2005
Q3 2005
Q1 2006
Q3 2006
Q1 2007
Q3 2007
Q1 2008
Q3 2008
Q1 2009
Q3 2009
Q1 2010
Q3 2010
Q1 2011
Q3 2011
Q1 2012
Q3 2012
Q1 2013
Q3 2013
Q1 2014
Q3 2014
Q1 2015
Q3 2015
Utilities Aggregate Net PP&E to Gross PP&E
Data Coverage: Quarterly from Sep
-
2001 to Dec
-
2015
Utilities S&P 1500 constituents, weighted by Gross PP&E
Source: Valens Securities
Conclusion
Net/Gross
PP&E
levels
are
at
long
-
term
lows,
indicating
that
management
teams
continue
to
be
wary
of
investing
to
grow
their
asset
bases,
even
in
the
low
interest
rate
environment
.
However,
at
current
levels,
it
is
simply
a
matter
of
time
before
firms
begin
to
invest
in
growth,
increasing
demand
for
credit
.
Furthermore,
incremental
interest
rate
hikes
could
actually
spur
aggressive
investment,
as
management
fears
about
missing
out
on
the
current
rate
environment
could
force
their
hands,
opening
the
door
to
the
second
stage
of
this
bull
market
where
higher
earnings
multiples
and
market
valuations
will
be
seen
.
Please
see
Valens
Research’s
most
recent
Market
Phase
Cycle
for
more
on
the
market’s
aggregate
performance
and
valuation
levels
.
Until
next
time,
Joel
The Litman Letter
July 2016
Page
7
Appendix
The Litman Letter
July 2016
Page
8
50%
51%
52%
53%
54%
55%
56%
57%
58%
59%
60%
61%
62%
63%
64%
65%
66%
67%
68%
69%
70%
Q1 2001
Q3 2001
Q1 2002
Q3 2002
Q1 2003
Q3 2003
Q1 2004
Q3 2004
Q1 2005
Q3 2005
Q1 2006
Q3 2006
Q1 2007
Q3 2007
Q1 2008
Q3 2008
Q1 2009
Q3 2009
Q1 2010
Q3 2010
Q1 2011
Q3 2011
Q1 2012
Q3 2012
Q1 2013
Q3 2013
Q1 2014
Q3 2014
Q1 2015
Q3 2015
Consumer Discretionary Aggregate Net PP&E to Gross PP&E
Data Coverage: Quarterly from Sep
-
2001 to Dec
-
2015
Consumer Discretionary S&P 1500 constituents, weighted by Gross PP&E
Source: Valens Securities
50%
51%
52%
53%
54%
55%
56%
57%
58%
59%
60%
61%
62%
63%
64%
65%
66%
67%
68%
69%
70%
Q1 2001
Q3 2001
Q1 2002
Q3 2002
Q1 2003
Q3 2003
Q1 2004
Q3 2004
Q1 2005
Q3 2005
Q1 2006
Q3 2006
Q1 2007
Q3 2007
Q1 2008
Q3 2008
Q1 2009
Q3 2009
Q1 2010
Q3 2010
Q1 2011
Q3 2011
Q1 2012
Q3 2012
Q1 2013
Q3 2013
Q1 2014
Q3 2014
Q1 2015
Q3 2015
Consumer Staples Aggregate Net PP&E to Gross PP&E
Data Coverage: Quarterly from Sep
-
2001 to Dec
-
2015
Consumer Staples S&P 1500 constituents, weighted by Gross PP&E
Source: Valens Securities
Appendix
The Litman Letter
July 2016
Page
9
48%
49%
50%
51%
52%
53%
54%
55%
56%
57%
58%
59%
60%
Q1 2001
Q3 2001
Q1 2002
Q3 2002
Q1 2003
Q3 2003
Q1 2004
Q3 2004
Q1 2005
Q3 2005
Q1 2006
Q3 2006
Q1 2007
Q3 2007
Q1 2008
Q3 2008
Q1 2009
Q3 2009
Q1 2010
Q3 2010
Q1 2011
Q3 2011
Q1 2012
Q3 2012
Q1 2013
Q3 2013
Q1 2014
Q3 2014
Q1 2015
Q3 2015
Healthcare Aggregate Net PP&E to Gross PP&E
Data Coverage: Quarterly from Sep
-
2001 to Dec
-
2015
Hea lth Care S&P 1500 constituents, weighted by Gross PP&E
Source: Va lens Securities
60%
61%
62%
63%
64%
65%
66%
67%
68%
69%
70%
71%
72%
73%
74%
75%
76%
77%
78%
79%
80%
81%
82%
83%
84%
85%
86%
87%
88%
89%
90%
Q1 2001
Q3 2001
Q1 2002
Q3 2002
Q1 2003
Q3 2003
Q1 2004
Q3 2004
Q1 2005
Q3 2005
Q1 2006
Q3 2006
Q1 2007
Q3 2007
Q1 2008
Q3 2008
Q1 2009
Q3 2009
Q1 2010
Q3 2010
Q1 2011
Q3 2011
Q1 2012
Q3 2012
Q1 2013
Q3 2013
Q1 2014
Financials Aggregate Net PP&E to Gross PP&E
Data Coverage: Quarterly from Sep
-
2001 to Dec
-
2015
Financials S&P 1500 constituents, weighted by Gross PP&E
Source: Valens Securities
Appendix
The Litman Letter
July 2016
Page
10
30%
31%
32%
33%
34%
35%
36%
37%
38%
39%
40%
41%
42%
43%
44%
45%
46%
47%
48%
49%
50%
51%
52%
53%
54%
55%
56%
57%
58%
59%
60%
Q1 2001
Q3 2001
Q1 2002
Q3 2002
Q1 2003
Q3 2003
Q1 2004
Q3 2004
Q1 2005
Q3 2005
Q1 2006
Q3 2006
Q1 2007
Q3 2007
Q1 2008
Q3 2008
Q1 2009
Q3 2009
Q1 2010
Q3 2010
Q1 2011
Q3 2011
Q1 2012
Q3 2012
Q1 2013
Q3 2013
Q1 2014
Q3 2014
Q1 2015
Q3 2015
Materials Aggregate Net PP&E to Gross PP&E
Data Coverage: Quarterly from Sep
-
2001 to Dec
-
2015
Materials S&P 1500 constituents, weighted by Gross PP&E
Source: Valens Securities
35%
36%
37%
38%
39%
40%
41%
42%
43%
44%
45%
46%
47%
48%
49%
50%
51%
52%
Q1 2001
Q3 2001
Q1 2002
Q3 2002
Q1 2003
Q3 2003
Q1 2004
Q3 2004
Q1 2005
Q3 2005
Q1 2006
Q3 2006
Q1 2007
Q3 2007
Q1 2008
Q3 2008
Q1 2009
Q3 2009
Q1 2010
Q3 2010
Q1 2011
Q3 2011
Q1 2012
Q3 2012
Q1 2013
Q3 2013
Q1 2014
Q3 2014
Q1 2015
Q3 2015
Telecommunication Services Aggregate Net PP&E to Gross
PP&E
Data Coverage: Quarterly from Sep
-
2001 to Dec
-
2015
Telecom.
Svcs.
S&P 1500 constituents, weighted by Gross PP&E
Source: Valens Securities
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Copyright 2014, Valens Securities.
All Rights Reserved. Please refer to the last page.
The Litman Letter
Joel
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Chief Investment Strategist
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Copyright 2014, Valens Securities.
All Rights Reserved. Please refer to the last page.
The Litman Letter
Joel
Litman
Chief Investment Strategist
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securities.com
+1 (646) 491 2601
DISCLOSURES
:
VALENS
CREDIT
CREDIT
ANALYSES
ISSUED
BY
VALENS
CREDIT
AND
ITS
AFFILIATES
ARE
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CURRENT
OPINIONS
OF
THE
RELATIVE
FUTURE
CREDIT
RISK
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COMMITMENTS,
OR
DEBT
OR
DEBT
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LIKE
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MAY
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ENTITY
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from
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third
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of
opinion
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of
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may
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OTHER
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INFORMATION
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MADE
BY
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IN
ANY
FORM
OR
MANNER
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securities
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Timeliness
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Relevance
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Valens
Credit,
Valens
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Conflicts
of
Interest
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receive
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reports
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©
2015
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Securities
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affiliates
(collectively,
“Valens”)
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