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Estimating maintenance capex

July 06, 2010 | About:

Bruce Berkowitz - The best example I can give on free cash flow is my first job in a corner grocery store behind the counter. People would come in and buy what they needed for the day. Money would go into the single cash register. From that cash register you would pay the bills. You would restock the shelves. You would keep the place clean, paint it every once in a while and pay employees. What was left was for the owner to keep. That’s the free cash.

This probably explains why investors look at GAAP FCF.

GAAP FCF = Cash from operations – Capital Expenditures

Cash from operations can be thought of as the cash left after paying the bills, restocking, keeping the store clean and paying employees.

Capital Expenditures is the cost of painting the store every once in a while plus the cost of any new stores.

To get a better idea of the earnings power of the business, we need to add back the cost of new stores to GAAP FCF.


Let’s assume a percentage change in revenue requires a corresponding change in property, plant, and equipment (PP&E).

In effect, a portion of the total capital expenditures equal to the difference between current net PP&E and starting PP&E accrues to expansion; the remainder is recurring or maintenance capex.

Let’s see how this works for the group of stores called Walmart. For this company the ratio of revenue to net PP&E is stable and roughly 4. The stability is important; it validates our assumption.

Net PP&E is now 100B in 2005 this was 70B. Revenue went up by about 125B over the same period. We conclude that in recent years, WMT increased PP&E by 30B to generate 125B of extra sales. Growth Capex is 30/5 = 6B annually or about 50% of total capex.

We could have saved ourselves the trouble and read the 10k. Walmart discloses the cash it spends on new stores (for its US operations). This is between 50% and 60% of capex for most years. Not all companies are this accommodating.

We can add the 6B to the FCF as reported to find cash earnings for Walmart as is (no growth)….. 15B + 6B say…. 20B.

20B annually is roughly what Walmart owners as a group could take home if they chose not to grow the business.

I leave it as an excercise to the reader to try this for BDX, PCP, DOW, MMM, KO. Alternatively, go to http://seekingalpha.com/article/158095-estimating-a-company-s-level-of-recurring-capital-expenditures A more numerate walk-through of the method can be found here: http://www.dailymarkets.com/stocks/2009/09/18/calculating-maintenance-capital-expenditure/

Why does this not work for company X ?

Remember, we assumed a percentage change in revenue corresponds to a change in property, plant, and equipment (PP&E). This assumption is crucial for the method to work. You may be looking at:

I ) A mine (also oil mines like COP). Mountains of cash can be spent developing reserves without any change in revenue for the period analysed.

II) A company that is very light on assets (PMD). You can do all the work and the result wil not be meaningful. Capex is minimal and adding back 100% of capex to FCF will not change anything.

III) A bank.

Final thoughts

In general this method is only safe if your basic assumption is correct. You could try tweaking the assumption to fit your needs.

Try unit volume instead of revenue if gross margins are wildly cyclical and/or use gross PP&E (add back accumulated depreciation). Also, for a business with a lot of inventory, you could try adding inventory to net PP&E. Inventory expansion is another factor masking the earnings power of a growing businesses.

Whatever ratio (some form of turnover over some form of assets) you use, the ratio must be stable over a number of years to be useful.

All questions and comments welcome as usual.

About the author:

I define intrinsic value as the price I would gladly pay to own the business outright. With current management in place. For most stocks, that value is 0. I can be reached at batbeer AT hotmail DOT com

Visit batbeer2's Website

Rating: 4.2/5 (24 votes)


Batalha - 7 years ago    Report SPAM
This is a simple yet one of the most important tools at arriving at Earnings Power of a company.
Guruinvestment - 7 years ago    Report SPAM

That is correct, however, you must not forget that you must fund receivables and inventories from year to year. Those expenditures are required to maintain operations and must be included along with cap expenditures.
Batalha - 7 years ago    Report SPAM
I would not include WC accounts in Maintenance Capex if you are doing a Earnings Power calculation (which assumes a no-growth, steady state scenario). I think you must include that if you are projecting into the future.
Batbeer2 premium member - 7 years ago
I would not include WC accounts in Maintenance Capex

Yes and no. Those items should not be added back in a steady state scenario; however any change in those accounts (not only are you funding the new store, you are also funding its inventory) may be worth adjusting for. These changes by definition mean the business is not in a steady state.
Batalha - 7 years ago    Report SPAM
First of all, WC is not CAPEX and the 2 should never be mixed up. Secondly, if you are funding a new store on new inventory that means it is not steady state scenario and you should include those accounts (thats what I meant by projecting into the future) so we definetely agree on that. I think the best way to think about Maintenance Capex is that it is the investment required at the end of the year to replete your asset base where it was at the begging of the year so you can keep on generating the returns you are having.
Batbeer2 premium member - 7 years ago
you must not forget that you must fund receivables and inventories from year to year.

>> Cash from operations can be thought of as the cash left after paying the bills, restocking, keeping the store clean and paying employees.

So, if you add back the growth fraction of capex, you have stiil got inventory turnover covered for the steady state.

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