Lesson 3 of 7
The capex that does not stop
A filed year with capital spending at nearly five times operating cash flow, free cash flow of negative 6,117 million, and the reason a company keeps spending.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- At one filer in one filed year, capital spending was 7,676 million dollars against operating cash flow of 1,559 million, or 492 percent.
- Free cash flow that year was negative 6,117 million, which is the same fact stated as a subtraction.
- Stopping a partly built facility can cost more than finishing it, which is a real reason and not a rationalisation.
The previous lesson measured what a bad year did to profit. This one measures what it did to cash, and the two answers are not the same shape.
Capital spending against operating cash flow at one filer, four filed years
- Capital expenditure
- Operating cash flow
Show the numbers
| Capital expenditure | Operating cash flow | |
|---|---|---|
| FY22 | 12,067$m | 15,181$m |
| FY23 | 7,676$m | 1,559$m |
| FY24 | 8,386$m | 8,507$m |
| FY25 | 15,857$m | 17,525$m |
The year
In the fiscal year ended 31 August 2023, the filer above paid 7,676 million dollars for property, plant and equipment and generated 1,559 million of operating cash flow. Capital spending was 492 percent of cash generation.
Free cash flow, operating cash flow less capital expenditure, was therefore negative 6,117 million dollars. That is the same fact written as a subtraction rather than as a ratio, and it is the version most readers find easier to hold.
Spending did fall: from 12,067 million the year before, a reduction of 36.4 percent. It did not stop, and it did not fall as far as revenue, which fell 49.5 percent over the same two fiscal years.
Why it does not stop
Three reasons, and all three come out of the structure of production course rather than out of finance.
Complementarity: a facility half built is not half a facility. Until the complements are in place it produces nothing, so the money already spent produces nothing either, and the choice is between finishing and writing off.
Specificity: the plant cannot be redeployed to another use while a decision is postponed. It is what it is, and the option to wait has a cost.
And lead time: a facility ordered now arrives in years, so a company spending through a trough is buying capacity for a period it cannot see and does not claim to. That is a statement about how long these projects take, not a claim about what happens next.
What this implies for a condition
A free cash flow condition on a capital-intensive filer will break in the trough, every time, for reasons that are structural rather than diagnostic. That does not make it a bad condition. It makes it a condition whose breach means something specific, and the thing it means has to be written down beside it.
The guardrails course takes this further: a condition whose expected behaviour is known in advance is more useful than one whose behaviour is a surprise, because a breach can then be read against the expectation rather than against nothing.
Check yourself
Capital spending was 7,676 million against operating cash flow of 1,559 million. What was free cash flow?
- Positive 6,117 million
- Negative 6,117 million, which is the same fact as the 492 percent ratio
- Not computable from those two figures
Show the answer
Answer: B.
Free cash flow here is operating cash flow less capital expenditure. The ratio and the subtraction say the same thing, and the subtraction is the more stable of the two.Why does capital spending not stop at a capital-intensive filer in a bad year?
- Because management is optimistic
- Because a half-built facility produces nothing until its complements are in place, so the money already spent produces nothing either
- Because the spending is contractually fixed
Show the answer
Answer: B.
Complementarity, specificity and lead time are the three reasons, and all three are properties of the assets rather than of anyone's expectations.What should a reader do about a free cash flow condition that will predictably break in a trough?
- Not write one
- Write down beside it what a breach is expected to mean, so the breach can be read against the expectation
- Set the level below the worst filed year
Show the answer
Answer: B.
A level set below the history rarely fires at all, which the thesis course identifies as the wrong way to choose one. Knowing what a breach means is the useful alternative.Sources
- Micron Technology, Inc., annual reports on Form 10-K for fiscal years 2022 through 2025, for capital expenditure and operating cash flow: fiscal 2022 accession 0000723125-22-000048; fiscal 2023 accession 0000723125-23-000054; fiscal 2024 accession 0000723125-24-000027; fiscal 2025 accession 0000723125-25-000028.
- The complementarity and specificity lessons of the structure of production course, for the three reasons given above.
What this leaves out
- This is a heterodox tradition. The mainstream account of the same phenomenon differs, and nothing here is a forecast or a view on any security.
- Capital expenditure as reported in a cash flow statement is payments made during the period. It is not a measure of commitments entered into, capacity ordered or projects started.
- Four fiscal years at one company illustrate a pattern in that company's filings. They are not evidence about capital-intensive businesses in general.
- Nothing here is a view on Micron or on any security.