European CEOs Are Finally Spending

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While activists are poking at Europe’s sleepiest companies with demands for short-term shareholder payoffs, the region’s business leaders are looking further into the future.

This year, Stoxx Europe 600 Index members are set to spend about 19.5 million euros ($22 million) per index share on average to renew old equipment and build factories, a sum not seen since the global financial crisis. It’s also the biggest year-on-year increase in such spending in more than a decade.

After years of shying away from investing in their own businesses, company chiefs are showing confidence in the region’s improving economy and more stable political landscape. While such spending lacks the allure of huge buybacks, special dividends or acquisitions for shareholders, a revival in capital expenditure could provide a welcome source of growth in a market where organic sales remain sluggish.

“There hasn’t really been a reason to do capex until recently,” said Thomas Thygesen, SEB AB’s head of cross-asset strategy in Copenhagen. “Europe is now growing in a way that is propelled by domestic demand. As a CEO, you can feel comfortable in committing to fresh equipment or building a new plant.”

Recent data suggests Europe is getting better at standing on its own, less dependent on a weak currency and export growth. Unemployment is at an eight-year low, surging factory orders have spurred the biggest manufacturing growth since 2011 and consumers haven’t been this confident in 16 years. Add receding political risk to the mix of supportive factors, with elections in the Netherlands and France delivering market-friendly outcomes.

Nowhere is the push to renovate Europe’s industrial prowess more evident than in Germany, where carmakers and machine builders are investing billions of euros to modernize their equipment and compete with rivals overseas. Among those is Siemens AG, whose CEO has so far managed to keep activist investors at bay and focus spending on building for the future. In France, telecom carrier Orange SA has set aside 7.2 billion euros to invest in its networks this year.

Activist investors tend to agitate for higher returns, often by opening up shareholder value through divestments, share buybacks and dividends. Spending on capital expenses and R&D locks up extra cash over a longer term.

At stake for European companies is lagging profitability, which suffers from the past decade’s double-whammy of financial and sovereign-debt crises in the region. At 5.5 percent, the Stoxx 600’s average profit margin is still only half what it was in 2007, and is dwarfed by the 9 percent margin for companies on the S&P 500 Index. The European measure has lagged its American counterpart every year since 2009.

The 13 percent expected increase in capital spending in 2017 marks a shift in trend. Companies spent years hoarding cash and bulking up their balance sheets, unwilling to commit to longer-term projects even as central-bank easing drove borrowing costs to the floor. Investors hunting for yield also piled into shares of firms that generated the most free cash, paid the best dividends or bought back shares.

That shareholder mindset is starting to turn, says KBC Asset Management’s Dirk Thiels, who prefers companies which reinvest in their own businesses versus those spending extra cash on buying back stock. While investors lauded Nestle SA’s $21 billion buyback plan last week and Clariant AG rose on Tuesday amid interest from U.S. activist investors, some of the biggest beneficiaries of increased capex -- in the construction and technology sectors -- have leapfrogged the Stoxx 600 in 2017.

“People are no longer thinking so defensively in Europe,” said Thiels, head of investment at KBC Asset in Brussels. “In this environment, capex can be the most beneficial. Cashing in a dividend or getting capital gains from a buyback is only a short-term win.”

(Updates with detail on activist investors in seventh paragraph.)
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