Not all capex lead to growth

No capex means no growth. And without growth, there is no wealth creation.

And as equity investors, wealth creation is our primary goal. Hence, we welcome capex announcements with an air of optimism and expectation that there will soon be a jump in profits and revenue.

But the question is, how often does capex actually lead to growth? History is ripe with examples of companies that bit more than they could chew, turned capex into mindless splurging, took on needless debt, and found themselves in a hole too deep to climb out of.

And at times, even if there's a foolproof plan, the stars just don't align, and the capex fails to deliver the promised land of better earnings.

For instance, here are the companies that spent the most on capex between FY13 to FY16.

As you can see, these companies (m-cap > Rs 1,000 crore) spent more than 20 per cent of their cumulative revenue between FY13-16 on capex. However, even after six years, the grand capex plans are yet to bring in the moolah as promised, and these companies recorded a revenue and PAT growth of less than 10 per cent between FY18-22.

So, what are the common factors that play spoilsport in capex plans?

Why capex fails
Getting too adventurous. Trying to be the jack of all trades eventually means you will be the master of none. Companies often try to expand into segments that have no relation to their core business, and unsurprisingly, these forays turn out to be disastrous. For instance, Videocon, after its stellar rise to the top of the consumer electronics segment, decided to venture into segments like telecom and oil and nearly got bankrupt.

Aggression without assessment. Capex should be executed at the right time and after enough research. Too many companies overlook macro scenarios and other factors affecting demand. They go for the jugular, splurging on expansion and find themselves with an inventory full of products with no buyers. For instance, Suzlon Energy doubled its manufacturing capacity without considering the fact that most of its clients were highly leveraged. As a result, most of its clients ended up cancelling their orders.

Overpriced acquisitions. Acquisitions are cost-effective ways to expand. However, while a good acquisition guarantees a boost in performance, a bad one often leads to years of capital drain. In 2006, Tata Steel acquired the four times larger Corus Steel to capture the European market. However, it did so after going into a bidding war and overpaying for the company. While the acquisition did help Tata become one of the leading steel manufacturers, it weighed heavily on the company's balance sheet in the long run.

Intense competition. A high competitive intensity is not the fault of a company, and sadly, it can ruin even the best thought-out capex plans. The prime example of this would be Mahindra & Mahindra. It spent Rs 15,664 crore on capex between FY13 to FY16. However, intense competition in the SUV segment led to a steep decline in market share from 52 per cent in FY12 to 15 per cent in FY23. As a result, instead of getting a boost from capex, its revenue shrank by -4.9 per cent between FY19-FY22. Similarly, Bharti Airtel's capex plans failed due to the cutthroat nature of the telecom industry.

Macros. No one can predict the markets. COVID, the banking crisis in US and Europe, Russian-Ukraine conflict are prime examples. Hence, at times capex plans fall apart due to unforeseen events. And companies in sectors with high capital requirements are especially vulnerable to this factor. Even in our above exercise, all the companies are from such sectors.

Note: We have excluded BFSI, realty and infra companies from our exercise.

Suggested read: There's more to growth than CAGR

This article was originally published on March 30, 2023.