Tuesday, January 30, 2007

CapEx Conundrum

Divining the future for small cap companies by reading macroeconomic tea leaves might be an exercise in futility. It is not that small caps are not impacted by economic conditions. Small size provides no inoculation against inflation, rising interest rates or political events that impedes growth. Yet we have found that in the greater mix of all factors weighing on small cap companies, matters specific to a company tend to cast a shadow across the big picture. This is especially true of a company has something “smarmy” going on with the management or the board.

No, smarmy is not in any financial analysis text book, but I do get down to text book questions every once in while. Take capital spending as one measure of macroeconomic conditions. I have been giving that considerable thought lately vis-a-vis one of the companies in my coverage universe,
Hurco Companies, Inc. (HURC: Nasdaq), produces computer controlled machine tools and sells them to fabricators in the U.S., Europe and Asia.

As a producer of durable goods, Hurco’s business is cyclic in nature. Investors always have to question when the party might be over. Hurco has had a good run, longer than some might have expected. With corporate earnings in recent quarters appearing to dry up, most might expect capital spending to dry up as well. Although counter intuitive, the slip in earnings in the last half of 2006, may be the trigger for more capital spending as manufacturers and industrial concerns seek higher profits through new and more efficient equipment. Indeed, durable goods orders are estimated to have risen almost 4% in December over November 2006. This followed a 1.5% increase in November over October 2006.

The high level of cash in the accounts of manufacturers could also make a difference in how assertive they will be in spending to boost profits. Purchases of new equipment will not necessarily require financing and that sort of freedom encourages investment.

Of course, a company with a first rate sales organization can flourish even when economies slow down. That takes us full circle back to topics specific to the company. For smaller companies with an aggressive strategy to capture market share (or the lack of any strategy at all) could be more telling about its future than an analysis of macroeconomic conditions.

Neither the author of the Small Cap Copy web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.
Crystal Equity Research currently has a buy rating on HURC.

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