My attic and Investing Journey

What are the different types of Capex a company does and how to judge the outcomes probabilistically?

1. Capital Expenditure is the type of expenditure any business or organisation does to add more fixed assets or plants and machinery. A simple example is, one factory owner deciding to put another factory with more machines. This we can classify as growth capex.

2. There is another type of Capex as well, where companies have replace existing machinery or where companies replace the worn out equipment. This is known as Maintenance Capex. 3. When it comes to Growth Capex- there are 3 types which we must understand with multiple examples. A) First type of Growth Capex is known as Green Field Capex. Where you set up a project from scratch. Now, since you are doing the capex for the First time on a piece of land. A lot of money will also get spent on basic utilities. Thus, your asset turns will always be low in a Greenfield investment. For eg:- Rainbow Children Hospital announced a Greenfield Capex at Gurgaon. Now given its a Greenfield capex in a hospital business it will take atleast 5-7 years to break even. Another example of Greenfield Investment is what SRF did in 2010 after Acquiring 293 acres of land at Dahej. They initially announced a 1000 crore Capex. Any capex done from scratch:- known as Greenfield capex. It is much more time consuming.

B) Second type of Capex is known as a Brownfield Capex. Where once your basic utilities and facility is in place. You can simply expand on the same site. A wonderful example of this is Mold-Tek Packaging. Which mentioned in its recent concall, that Asset turns (how much sale can be generated from Rs1 of assets) are 1.5x in Greenfield investments and 2-2.5x in Brownfield. Unit level economics end up improving. SRF which bought a 293 acre land, over the years kept on doing capex at the same piece of land. Over time, the invested capital turnover from that land parcel has gone from 0.7x to 1.1x. Thereby, helping to improve Profitability of the chemical business. (Major role is by margins, read about Local economies of Scale). It is less time consuming.

C) De-bottlenecking This is a type of Capex where minor changes like changes in machine configuration, pin pointing the bottlenecks or Changing the workflow configuration (Think having a seperate warehouse). Can massively improve the Asset turns and Profitability of the business. For eg:- A company manufacturing Phenol in India is increasing its achievable capacity by 50% just by doing a capex of 100 crores. Original capex amount that was spent to set up the plant was 1400 crores. You will often find such terms in a manufacturing business. Another company into Amines business, just by small de-bottlenecking of 30 crores was able to generate incremental revenues of 450 crores!(15x). Whereas, original asset turns were 1.5x.

D) Non Revenue Generating Capex:- I will further divide such capex into two parts:-

(i) Maintenance Capex:- This is the type of Capex that is done to replace the old machinery and to maintain the Fixed Assets. This is done to ensure that the business keeps functioning and old assets are replaced. One rule of thumb is to substitute Deprecation amount as the regular maintenance capex that is done every year. Earlier BKT Industries announced 350 crore as replacement or maintenance Capex at its old plant at Waluj (recently shelved) Broad rule of thumb= Depreciation will be equal to Maintenance Capex. Sometimes managements in concalls or interviews give the exact Maintenance Capex numbers.

(ii) Capex done to ensure Business becomes more sustainable:- Check the Falling Fixed Asset Turns of Aarti Industries:- 2018: 1.9x 2019: 1.94x 2020: 1.69x 2021: 1.25x (FY22, 23- Had termination income etc- tough to compare) One of the reasons is that the Company did significant capex on Sustainability as well to make its plants ZLD, and more environmentally friendly.

4. How to check visibility revenue & competitive positioning while companies are incurring Capex spends?

A) Some companies by their nature of the business will do Capital Expenditure and the business will be done on a Spot Basis. Spot means- there are no confirmed buyers, you just go to the market and sell on the Spot. Generally, products which can be replicated or a bit commodity in nature. Such companies will end up doing Capex without confirmed commitments. Eg:- Deepak Nitrite’s Phenol capex can be one such example. Another one is, Dynemic products ( A food cooler company). Which did massive Capital expenditure, and once capex was commercialised the demand softened+Raw Material prices increased. The company went under losses due to elevated depreciation & Interest cost. Spot Capex- For an investor judging the utilisation can be tricky. You really need to understand the companies market position & demand for the products along with the supply side scenario. If too much supply comes in and demand is soft. Even then the market goes through a downturn. Think about what happened with Transformer companies in 2011-2020. Too much supply and less demand for the products. Understanding Market supply & demand dynamics is really important in such companies. Gives opportunities to smart investors to do cyclical investing, and often many investors go wrong here as well. Recent cycle has been the Polypackaging one, where demand grows at X and Supply is going up by 3-4x in next 1 year. Companies are already in cash losses.

B) Confirmed Contracts Capex:- Think about few companies such as PI or NFL or Deccan etc. These companies are doing capex on the basis of long term confirmed contracts. Here the visibility becomes much higher, even analysts start baking that into their projections as revenue ramp up is usually given by companies in their concalls. Example from the past:- NFL did 400+ crores of capex for a Confirmed long term contract with Honeywell for their patented Ref gas. The moment capex was announced, PE got rerated as visibility for analyst community increases.

C) Capex with high visibility:- One of the Coffee Companies in India has announced expansion of its Facility in Vietnam. This expansion comes on the backdrop of the fact that 50% of the expanded capacity is already booked out by a customer. It gives high degree of confidence to go ahead and do capex.

D) Capex for Stores:- In retail businesses or QSR businesses. Companies like Titan, Westlife or Trent will give broad visions of setting up xxx number of stores. An easier way to understand the potential revenue generation will be:- Multiply revenue per store that has been achieved*New number of stores that are being opened. Once these stores become fully mature, this will give you a rough idea on how much sales the company can generate once the stores are fully mature.

E) Capex done for Backwards integration:- Companies that want to make their Raw Material in house will incur capex for backward Integration. Eg:- BKT Tyres doing capex for Carbon black which is a Key Raw Material. Another example where things went South is:- Usha Martin setting up a steel plant to manufacture steel wires. Due to debt that was taken and inherent volatility in steel prices. The company went bankrupt and had to get its debt restructured+Ended up selling the steel plant. Backwards integration can cut both ways if not thought well by the Promoters.

F) Opex for Branches:- When Banks and NBFC’s open significantly higher amount of branches. This spend is termed as OPEX or Operating expenditure. Once, higher number of branches are opened then in the near term Cost to income (how much rupees you are spending to earn) goes up. As new branches reach maturity, then AUM per branch and productivity per branch keeps improving. Over a period of time the Cost to income ratio falls. Think what is happening with HDFC Bank right now. These are few musing on Capex

Hopefully you found value in reading this post. Thank you for your time. Disclaimer: Nothing in this post is a buy or sell recommendation. Sole purpose is to share how to think about Capex with retail investors