Depreciation As A Percentage Of PP&E At 15-Year Low

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At the end of last year, many analysts were predicting corporate capex would be fairly low this year, around 1.5%, but recently there have been indications that the true number could be closer to 5% because maintenance costs that have been delayed as companies tried to survive the recession could provide another boost to capex growth.

“In order to see if that capex has been enough to cover required maintenance, we looked at depreciation expense as a percentage of PP&E for S&P 1000 (INDEXSP:SP1000) companies,” writes Citi analyst Josh Levin. “The ratio of depreciation to PP&E now stands at a 15-year low.”

Companies may still be in crisis mode

Since it’s standard procedure to depreciate real assets (PP&E stands for property, plant and equipment) over the course of their useful lifetime, the drop in depreciation implies that many assets are reaching the end of that lifespan and will soon be in need of replacement or serious repairs. (This also explains the lag; when companies stop putting money into PP&E, the drop in depreciation won’t show up for at least a couple of years). That doesn’t mean that maintenance capex has to increase this year, but a company that isn’t afraid of going under can only put it off for so long.

For those who have been disappointed by the pace of U.S. economic recovery, the cautiousness evidenced in this graph may be to blame. If companies are still in crisis mode, they may prefer to push back costs and keep cash on hand when possible, but companies will eventually need to make up for those expenses when they want to return to business as usual.

Higher capex should drive loan growth

Even if some of these maintenance capex costs are paid for with cash, the low ratio of depreciation to PP&E should put some upward pressure on loan growth as well. Loan growth hasn’t exactly been a problem recently. Major banks like Wells Fargo & Co (NYSE:WFC) and U.S. Bancorp (NYSE:USB) had stronger numbers last quarter than had been expected, and financials have already grown faster than in most other sectors, but anything that boosts growth is welcome.

Besides, when companies are comfortable financing costs that aren’t both important but not absolutely essential, it will signal their confidence that the worst is behind us. Also the extra spending from pent-up demand could spur growth beyond the financial sector.

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About the Author

Michael Ide
Michael has a Bachelor's Degree in mathematics and physics from Boston University and Master's Degree in physics from University of California, San Diego. He has worked as an editor and writer for several magazines. Prior to his career in journalism, Michael Worked in the Peace Corps teaching math and science in South Africa.

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