What do you call it when companies Increase their outflows for CAPEX while at the same time INCREASING their free cash flow margins?  An interesting article by CFO.com today calls it one of the first truly positive signs since the recession began.


When the recession began, companies began hoarding cash as a buffer against further uncertainties and downturns.  One of the most common methods of increasing free cash flow in a recessionary economy (and thus building up cash) was to significantly reduce CAPEX (Capital Expenditures) investments, thus reducing significant outflows below even their reductions in revenues.  This had the desired outcome of increasing cash on the balance sheet of many companies, as every quarterly Fed report continues to show record levels of cash in U.S. non-financial companies, with the same pattern holding true in Europe as well.


But companies can not hold off CAPEX investments forever as entropy is an immutable law of nature and buildings wear down and equipment wears out.  And logically, in a stagnant economy, an increase in CAPEX investments would lead to a corresponding decrease in free cash flow and/or free cash flow margin (free cash flow as a percentage of revenue).  However, "Free cash margin for firms with a market capitalization greater than $50 million rose to 4.54% for the 12 months ended December 2011, up 0.13% from 4.41% in September 2011."  While at the same time "In the 12 months ended December 2011, ...capital expenditures rose to 3.41%, up from 3.29% recorded in September"


According to Chuck Mulford, professor of accounting at Georgia Tech and director of the university’s Financial Analysis Lab, "This is the first reporting period since before the recession that we’ve seen increased spending on capital expenditures and increases in inventory [while] no longer seeing a decline in free cash flow margin. We’re seeing an uptick. We haven’t seen that now in years."


Bottom line:  this is a hopeful sign that businesses are investing again and growing their businesses...but it is also a sign that the levels of balance sheet cash built up is not going anywhere soon.


We saw it with Apple last month as they announced a dividend payout that will have no appreciable effect on their cash pile, and we see it now with companies increasing investment, but seeing free cash flow margin increase in a commensurate manner.  Companies are going to continue to hold significant cash for quite some time and with short term interest rates tanked, they are going to continue to face the challenge of keeping that cash safe while still earning yield for shareholders. 


Many companies are doing exactly that with Dynamic Discounting  Check out here and here to learn more about it.