Belgian capex plans: no place for despondency, but not all capex is created equal

Pessimism prevails in Europe. The continent has been hit by high energy costs and slow or even negative economic growth. The population is not business-minded and politicians and the public are risk-averse. Regulation and bureaucracy are crippling entrepreneurship, certainly when compared to areas of bustling economic activity in the US, parts of the Middle-East and Asia. And yet a handful of European companies are thriving. Mostly it is because they are global leaders and/or because they are at the forefront of innovation like. Despite big geopolitical and macro uncertainties these companies keep a high investment rate in order to guarantee a bright future.

 

The Belgian Context

In Belgium, the context looks even more troublesome. Overregulation and stringent new environmental restrictions make it hard to even get permits for expansion. As a small nation, Belgium also seems to be the victim of the new leniency in Europe towards state subsidies. Major projects like a new state of the art battery recycling project by Umicore or the renewal of the electric furnace of ArcelorMittal in Gent, Flanders could fall for the lure of much higher French subsidies (and lower electricity prices). “De-industrialisation” has been going on for years. And yet, when we look at a handful of quoted Belgian companies we notice that they have not put their investments on the backburner. Nevertheless, most new investments take place outside of Belgium.

 

In our analyses, we only considered maintenance and growth capex, ignoring M&A and R&D which for many companies represents often the largest investment. Given this constraint, we focus more on traditional industries. Furthermore, we take on the angle of an investor. As a general rule, investors prefer companies with an “asset light business model”.  Recurring topics are capital intensity, capital structure, transparency and expected returns. Companies that invest more should in theory realize higher returns. But is this really the case?

 

A case study on Lotus Bakeries

The easiest case study is Lotus Bakeries. It is by far the most successful quoted Belgian company. 2023 was another year of triumph with sales up 21% and earnings even up 25%. Sales CAGR over the last decade was 12.3%. Success is founded on a few strategic decisions taken in 2015. International growth is focused on Biscoff. With Natural Foods Lotus invaded a new market segment, while it still fosters its strong local brands. Lotus is highly ambitious. Biscoff is now the fifth most sold biscuit in the world. It aims to move up in the global pecking order. To get to number three, sales will have to more than double. But, just like the company was gradually built over the last 80 years, it will not take rash and dangerous decisions and overinvest.

Lotus invested 242 mln EUR in the last 2 years (153 mln in 2022, 89 mln EUR in 2023). Normal capex/sales ratio hovers around 6.5%.  Net debt “peaked” in 2022 at 154 mln EUR and already dropped to 120 mln EUR in 2023, living proof of the strong cash generation (FCF on sales is around 9%). Net debt/EBITDA was a mere 0.60 pointing to a very strong balance sheet. Lotus provides a good overview of its production footprint. It also gives clear information on where the capex is spent with clear timelines (a new factory in the US, in South Africa and in Thailand). The company is ready for its next decade of growth, in order to celebrate its 100th anniversary in 2032.

Lotus is the perfect paragon for any entrepreneur who wants to learn how to build a superb company. It took three generations, though. Growth has accelerated in recent years, but the strong foundation was laid many years ago. It all starts with excellent products, strong corporate values, a clear strategy and consistent execution. Sounds simple, yet very few companies arrive at such high standards.

 

A look on Barco

When comparing with Barco, we see quite a different picture. Barco spent 19, 21 and 54 mln EUR on capex in 2021/22/23. That was 2%, 2% and 5% of sales. Capex is clearly not the key investment effort for Barco, that on average spends 11-13% of its sales on R&D. However, it is interesting to note that Barco has opted to build its “focused factories” in China. To increase competitiveness it will operate two dedicated Chinese factories per end-market, with for each one a back-up factory in Europe and no production sites in the US. It also invests in “cinema as a service”. According to Barco, focused factories offer the following benefits: a simplification of the production processes, speeding up decision making and efficiency, improving product quality, enabling product and process innovation and it moves Barco up within the value chain while limiting supply chain risks.

The Healthcare production plant (displays) in Suzhou already ramped-up in 2023, with transfer of products from European factories (Saronno, Italy) nearly completed. In Wuxi, a new Entertainment plant (projectors) is being constructed. Product transfers will start in 2024. There has been a lot of talk of “reshoring” or bringing industrial production back to Europe. Here, we see the exact opposite. Barco wants to seize the growth potential in China by having a strong local presence. These factories are highly automated. In Suzhou, a fully automated glass-bonding line will be ready by Q2 2024. In Wuxi, the company will implement fully automated workcells which are connected to an automated warehouse via Automated Mobile Robots and Automated Guided Vehicles. The Kortrijk production unit now boasts automated laser driver assembly cells. These ensure the accuracy and quality that manual processes cannot guarantee for certain components. Automation allows to build high-precision laser assemblies (digital cinema projectors). And by insourcing activities, Barco wants to reduce supply chain risks. It has also been investing in “value engineering”, making production more efficient. Barco tries to kill two birds with one stone: increasing its global competitiveness as well as enhancing its Chinese profile. It is also planning a new manufacturing site for Healthcare in Saronno and it wants to integrate all Kuurne activities onto the Kortrijk campus to foster cooperation between R&D and Sales&Marketing. As said before, the majority of investments are not merely in factories, but rather in R&D. More information on digital transformation can be found in the 2023 annual report (p 28-29). Despite these efforts and despite high investment in working capital (174 mln or 16.6% of 2023 sales) Barco has kept a pristine balance sheet. After distributing 40 mln EUR in dividends and spending 8 mln EUR on a share buyback (to cover management options) it still had 241 mln EUR in net cash. The company has been increasingly vocal on potential M&A. 

 

Xfab and Melexis

Apple is perhaps the world champion of the asset light model. It invents, designs, outsources, markets and rakes in the cash. The brunt is on the suppliers. In Belgium, we have a symbiotic relationship between Xfab, doing the heavy capex investing, and sister company Melexis, focusing on chip design and innovation. The biggest risk is that Xfab will keep on investing without ever reaping the fruits of its investments. Granted, EBITDA increases, but in the end it is free cash flow that matters. Announcements of big capex plans mostly get the thumbs down from investors. We recently saw this when Xfab shocked the market with a huge capex investment, coupled with a subdued outlook for 1Q 2024. After spending 350 mln USD in 2023, Xfab forges ahead with a whopping 550 mln USD in 2024, followed by another 300 mln USD in 2025. It primarily concerns a big expansion in Malaysia, with revenues only increasing from 2Q 2025 onwards. This huge expansion capex will be financed by 400 mn USD of available cash, 200 mln EUR new credit lines and some additional support from its suppliers (via LTA’s: long term agreements). Financing its huge 1.2 bn USD expansion capex does not seem to be a problem. Normal capex for Xfab is around 15% on sales. This year it will be over 50% of sales! The question that keeps investors awake at night is whether there will be a sufficient return this investment. The jury is still out as it will take a few years before Xfab will be at cruising speed.

Melexis on the other hand, invested  94.74 mln EUR in 2023, a big jump from the 39.9 mln EUR in 2022 and 40 mln EUR in 2021. Capex guidance for 2024 is for 70 mln EUR, as was the case early 2023 (at mid-year increased to 100 mln EUR). Information on the capex projects is rather scarce. Investors have to find out during conference calls, roadshows or corporate visits. Even at its CMD there was hardly any talk about capex. Capex on sales of 9.8% was exceptionally high in 2023. Historically, its capex/sales ratio hovers between 6 and 7%. No wonder its free cash flow (FCF) ratio on sales is about 18-19%. Return on equity is easily above 30%, as well as return on capital. In a recent interview (https://www.melexis.com/en/news/2024/2024-is-the-year-of-people-innovation-and-optimization), the CEO of Melexis did not mention capex either. It was all about innovation. The heavy capex load rests on Xfab’s shoulders. Minority investors might wonder whether it makes sense to invest in semiconductor fabs. Investors in Melexis are offered a juicy dividend (3.70 EUR in 2023, a gross yield of 4.7%). Investors in Xfab who bought the stock during its IPO in April 2017 at 8,00 EUR are still in the red, while a dividend has never been paid and is not expected in the foreseeable future. Could there be a curse on capex heavy companies? Simply put, growth at Melexis translates into free cash flow, whereas growth at Xfab translates into heavy capex and accompanying higher depreciation. Xfab has a high EBITDA margin, but negative free cash flow.

 

Subsidies for big multinationals

A trick to lower the capex burden is to collect government subsidies. Big multinational companies are masters at this game. Syensqo (then Solvay) is making big investments in the US. In 2022, it created a joint venture with Orbia to build the largest PDVF-facility for battery materials in North America. The total investment was estimated to be around 850 mln USD, expected to be funded in part by a grant awarded by the U.S. Department of Energy of 178 mln USD to Solvay to build a facility in Augusta, Georgia. Cheap energy and huge subsidies are the main reason why so many companies prefer to invest in the US rather than in Europe. The CEO put it bluntly: “Europe gives us regulation, the US gives us money.” There is much talk of the need for an “industrial renaissance” in Europe. In reality, there is a race amongst European countries to attract new investments. Central Europe and large countries mostly win. The first because they offer space and cheap skilled labour, the latter because they have the deepest subsidy pockets. This kind of investment often carries a high degree of uncertainty about future returns. Umicore is a case in point. It plans to invest 2.6 bn EUR over 2022/26. That is about half of its current market cap. Again, huge subsidies from the Canadian government help support the burden. Key customers will also help with the financing. Nevertheless, the share price lingers below the level reached in April 2015. In recent years, critical analysts have pointed out that Umicore was losing the battle in the battery wars against its Korean and Chinese opponents. Umicore’s management begs to differ, claiming that it has competitive technology allowing for flexible production. Furthermore, Umicore already has plants in South Korea, China and Europe and is constructing a new one in Canada. That is why it concluded key long-term partnerships with major OEMs like Volkswagen and Stellantis. Maybe Umicore will indeed be a winner. If so, it is only expected to become visible from 2026 onwards. There is another question bothering investors. Recently, the whole sector has been in the doldrums. Share prices of Chinese and South Korean competitors are also at rock bottom. That is because the future profitability of the whole sector is put into question.

 

Concluding remarks

The conclusion is obvious. Not all capex is created equal. The bigger the investment, the more investors should be wary. In general, companies don’t provide enough insight into the returns of these investments. Investing for investment’s sake is good to keep a company alive, but deadly for investors. We calculate that BASF has invested over 90 bn EUR in capex since 2002. This has never translated in decent returns. Earnings peaked around 5.7-6.2 EUR per share in 2010/12 and have since come down to less than 4.00 EUR. The share price is at levels already reached in 2007. Current dividend yield is 7.5%, the highest yield ever (except during periods of market turmoil). That is unfortunately proof of investors holding their thumbs down. When faced with big capex plans, investors better to keep a close watch.