To reverse the cliché, every silver lining is covered by a cloud. That's something CFOs should remember as they focus on a metric that most hold dear: free cash flow. For many finance chiefs, the ability to liberate cash from revenue and its attendant costs gets at the very heart of their value to the organization.

Investors, boards, and chief executives tend to regard such free money as a cloudless benefit. But free cash flow isn't completely free, particularly if it is generated at the expense of a company's (not to mention an economy's) ability to grow.

During the financial crisis, many corporations shifted into survival mode, slashing expenses in order to maintain enough liquidity to pay down debt or provide a backstop against future financial meltdowns. Unfortunately, a big portion of that ax-wielding entailed cuts to long-term productive corporate assets like property, plant, and equipment.

Two diverging trends tell the story. After reaching a three-year low of $14 million in December 2008, reported median free cash flow for about 4,000 U.S. public non-financial-services companies soared, doubling to about $28 million by March 2010 (according to a study by the Georgia Tech Financial Analysis Lab using data provided by Cash Flow Analytics).

That marked the highest level of free cash flow in at least 10 years. On the other hand, starting in March 2008, reported median net capital expenditures (capex) as a percentage of revenue plunged to less than 3% in March 2010, a 10+ year low.

Together those two metrics tell a dark tale indeed, say some experts: the drastic cutbacks in capex amount to firms swapping long-range economic health for a short-term glow to please (or at least appease) investors. "Over the last few quarters, free cash has been growing for many companies, but they've been achieving it in nonrecurring ways," says Charles Mulford, a professor of accounting at Georgia Tech and managing director of research for Cash Flow Analytics. Those ways include "the crutch of reducing capex to grow free cash flow," he says, along with reducing inventory and expenses.

There is no denying that in this still-uncertain economy, holding tightly to your cash can make a great deal of sense (see "Time to Get Off Your Cash?" July/August). And, along with preserving liquidity, another reason for capex caution may be that boosting capex could run counter to the perpetual push for manufacturing efficiency: how "lean" can a company be if it's pouring money into plants and equipment?

Pretty lean, as it turns out — at least in some cases. A few large public companies have maintained an upward trend in capex as well as healthy free cash flow over a relatively long period, according to an analysis of Cash Flow Analytics data conducted for CFO by Mulford. Six U.S. public, non-financial-services companies with market caps of more than $1 billion grew their capex/revenue ratios by more than 10% over the one-year and three-year periods ending in March 2010, even as they maintained positive free cash flow.

And several dozen other companies, while showing some quarter-to-quarter fluctuations, also maintained stable capex growth at a time when most of their peers were loath to part with cash for any reason. What kinds of companies are they? What are their strategies? How have they managed to keep investing for the long term in the face of a powerful economic downturn? And what can your company learn from them as the crisis abates and strategies pivot slowly away from cost-cutting and toward growth? Based on interviews with finance executives, here are six common traits of companies that have bucked the trend.

1) They Are in the Right Place at the Right Time.
There is no denying that when it comes to spending big, or at least bigger, on capex, it certainly helps to be in an industry that is outpacing the general economy. These days that largely means health care, energy, aerospace, and business-process outsourcing. For many companies in these sectors, steady increases in capex are almost mandatory because they are the market leaders and they want to keep the competition at a distance. Esterline Technologies, for instance, is a specialized manufacturing company that derives about 80% of its sales from the aerospace and defense industries and 20% from the application of its technology elsewhere. While the
commercial-airline industry that it serves has been hit hard by the recession, the company's defense contracts assure it a solid base of revenue for years to come.

Virtually all of Esterline's operating units are number one or number two in their niches, according to Bob George, the company's CFO. The finance chief freely acknowledges that Esterline's strong market position has enabled it to boost its capex-to-sales ratio over the last three years. "I don't think you can take any company's investment decisions out of context from the industry it competes in," he says.

• 1
• 2
• 3
• next »

LinkedIn Company Connections:

• Esterline Technologies |
• Maximus Inc. |
• Owens-Illinois |
• Cash Flow Analytics LLC |
• Integra LifeSciences Holdings |
• The Shaw Group |
• Express Scripts |
• Dendreon |
• NCR |
• MEMC Electronic Materials |
• Overseas Shipholding Group |
• Patterson-UTI Energy