Why you should be scrutinising capital-intensive stocks

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.”

Capital intensive stocks

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.

“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.”

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