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U.S. Fixed Income

Signs Point to Slowing Capex

We anticipate decelerating capex among investment‑grade corporate issuers.

Lauren T. Wagandt, Associate Portfolio Manager
Key Insights
  • We do not expect capital expenditure growth in investment‑grade corporates to boost broader U.S. economic growth.
  • Capital spending in commodity‑related sectors is particularly susceptible to slowing; coupled with better productivity in these industries, this is positive for credit quality.
  • We favor shorter‑maturity debt and are overweight the energy sector within the investment‑grade corporate bond asset class.

Several trends among issuers of investment‑grade corporate debt, including decelerating growth in EBITDA1 and increasing prioritization of share buybacks, lead us to expect capital expenditures (capex) in the asset class to slow. As a result, capex among investment‑grade companies is unlikely to provide meaningful support to economic expansion. Our outlook for decelerating capex growth contributes to our defensive positioning in the asset class, where we favor shorter‑maturity debt to reduce exposure to potentially deteriorating credit quality.

Capex Strongly Correlated With EBITDA

Investment‑grade corporate capex growth is strongly correlated (R2=0.82) with EBITDA growth on a two‑quarter lag.2 Year‑over‑year EBITDA growth has been slightly decelerating since the second quarter of 2018. While year‑over‑year capex growth has been accelerating modestly, we expect capex to follow EBITDA by downshifting to a flat or declining pace later in 2019.

Industries Related to Commodities Drive Capex

Commodity‑related industries, including energy and metals and mining, account for 32% of capex within investment‑grade corporates, so these sectors drive capex trends within the broad asset class. Also, commodity‑related sectors tend to be more volatile, so they also have a disproportionately large effect on the rate of change for investment‑grade corporate capex. Earnings growth in these industries has been slowing, which contributes to our outlook for decelerating capex.


32%
Percent of capex within investment‑grade corporates that commodity‑related industries account for.

(Fig. 1) Capex Trails EBITDA With Two-Quarter Lag

EBITDA and capex growth (two-quarter lag)

As of December 31, 2018

Source: J.P. Morgan. Information has been obtained from sources believed to be reliable, but J.P. Morgan does not warrant its completeness or accuracy. The index is used with permission. The Index may not be copied, used, or distributed without J.P. Morgan’s prior written approval. Copyright © 2019, J.P. Morgan Chase & Co. All rights reserved.

In addition, T. Rowe Price’s metals and mining and energy credit analysts point out that productivity improvements in these sectors has allowed companies to achieve similar growth with lower capital spending. As a result, we hold overweights to energy‑related issuers in our investment‑grade corporate portfolios as the combination of productivity improvements and improved capital discipline is positive for credit quality.

Opening Quote Corporate management teams tend to use stock buybacks as a discretionary tool to support equity prices, contributing to the volatility of these actions. Closing Quote

Shareholder‑Friendly Actions Back in Vogue

Our credit analysts covering investment‑grade issuers also note that companies have been prioritizing share buybacks and dividend increases—shareholder‑friendly actions—over capex following the implementation of U.S. tax reform at the beginning of 2018. While we see no immediate catalyst for this trend to turn in favor of capex, shareholder payouts have historically been more volatile than capex, rising more quickly during periods of growth and falling more rapidly in contractions. Corporate management teams tend to use stock buybacks as a discretionary tool to support equity prices, contributing to the volatility of these actions.

(Fig. 2) Capex to Slow With Energy EBITDA Growth

Commodity EBITDA and capex growth (two-quarter lag)

As of December 31, 2018

Source: J.P. Morgan (see Fig. 1).

(Fig. 3) Higher Shareholder Returns Weigh on Capex

Capex and shareholder payout growth

As of December 31, 2018

Source: J.P. Morgan (see Fig. 1).

Investment‑Grade Corporate Capex Unlikely to Support Economy

All of these trends indicate that capex growth in investment‑grade corporates is likely to flatten out or gradually decelerate in the latter part of 2019. Because business investment is a key component of gross domestic product (GDP), capex ultimately can lead to higher GDP. However, based on our analysis of the investment‑grade corporate asset class, capex is unlikely to accelerate, so we believe it is doubtful that an increase in business investment will contribute a meaningful boost to GDP.

Opening Quote We broadly favor shorter‑maturity positions that reduce our exposure to the deteriorating credit quality that is common in the later stages of the economic cycle. Closing Quote

Favor Shorter Maturities, Energy Issuers

In terms of the positioning of our investment‑grade corporate bond portfolios, this outlook for decelerating capex is a factor in our overall defensive stance. The pickup in shareholder‑friendly corporate actions that has come at the expense of capex has limited improvements in credit quality, with leverage remaining elevated in the asset class. We broadly favor shorter‑maturity positions that reduce our exposure to the deteriorating credit quality that is common in the later stages of the economic cycle.

At the industry level, we favor the energy sector because of its improved corporate efficiency and capital discipline. At the individual security level, our credit analysts incorporate their knowledge of corporate management’s tendencies toward spending on stock buybacks or dividends versus capex into their credit quality profiles.

WHAT WE’RE WATCHING NEXT

If the trend continues, the sharp upturn in the prices of oil and other commodities in the first quarter of 2019 could affect both productivity and capital spending at investment‑grade companies in the energy and metals and mining industries. T. Rowe Price’s energy analysts believe that further gains for oil are possible in the shorter term, but productivity improvements at U.S. shale oil producers are likely to boost supply and push prices down in the longer term.

1 Earnings before interest, taxes, depreciation, and amortization. [Return to Text]

2 R2 measures the degree of correlation in regression analysis, with 1 indicating perfect correlation and 0 indicating no correlation. [Return to Text]


Key Risks—Tthe following risks are materially relevant to the strategy highlighted in this material:
Transactions in securities of foreign currencies may be subject to fluctuations of exchange rates which may affect the value of an investment. Debt securities could suffer an adverse change in financial condition due to ratings downgrade or default which may affect the value of an investment.


Important Information
This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, and prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request. It is not intended for distribution to retail investors in any jurisdiction.

USA—Issued in the USA by T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore, MD, 21202, which is regulated by the U.S. Securities and Exchange Commission. For Institutional Investors only.

© 2019 T. Rowe Price. All rights reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the Bighorn Sheep design are, collectively and/or apart, trademarks of T. Rowe Price Group, Inc.

201904-832180

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