Bruce Greenwald’s Method to Calculate Maintenance Capex
In a previous post on how to calculate maintenance capital expenditures, I outlined the general aka quick and dirty method of calculating maintenance capex which is
Maintenance Capital Expenditure = Depreciation and Amortization
Although if you smooth out all the depreciation values across several years, you’ll be okay with your numbers, but what if you want to go one step further?
Since depreciation can be misleading, you may be missing out on opportunities by unknowingly using a unrealistically high number for maintenance capex calculations. This is where Bruce Greenwald’s method of calculating maintenance capex makes a lot of sense.
Calculate the ratio of PPE to sales for each of the five prior years and find the average. We use this to indicate the dollars of PPE it takes to support each dollar of sales. We then multiply this ratio by the growth (or decrease) in sales dollars the company has achieved in the current year. The result of that calculation is growth capex. We then subtract it from total capex to arrive at maintenance capex. – pg96 of Bruce Greenwald’s EPV book.
The above text in an understandable manner is as follows: (from my Value Idea)
- Calculate the Average Gross Property Plant and Equipment (PPE)/ sales ratio over 7 years
- Calculate current year’s increase in sales
- Multiply PPE/Sales ratio by increase in sales to arrive to growth capex
- Maintenance capital expenditure is the capex figure from the cash flow statement less growth capex calculated above, which is the true depreciation for the company
I also have been able to implement this into the stock investment spreadsheet to perform the calculations automatically with just a single ticker input. I’ll be using screenshots of the investment spreadsheet to take you through the examples. (The stock value calculation spreadsheet that supports EPV and the images below will be released in October)
Maintenance Capital Expenditure Calculations
Wal-Mart is an easy example to start off with because of its consistency.
- From 2005 to 2009, WMT PPE as a percentage of sales ranged from 21.2% to 25.4%.
- The 2nd line shows the sales increase. It is simply calculated by this years sales minus last year sales
- Capex line is the actual stated amount of capital expenditures in the financial statements
- To calculate the maintenance capital expenditures for 2009 you do 25.4% x $26,808 = $6,809
- The $6,809 value is the growth capex so then subtract the result from Capex to get $11,499-$6,809=$4,690
- $4690 is the maintenance capital expenditure amount WMT used in 2009.
Compare the value of $4690 to the stated depreciation and amortization amount of $6,739. Look at the difference in values between 2005-2009. Since depreciation and amortization is a straight line approach in accounting, the amount is increasing while maintenance capital fluctuates depending on the business cycle.
So it seems like that the method Bruce Greenwald teaches is a much more accurate representation of maintenance capex.
Heavy Capital Expenditure Companies
The only problem I see at the moment in applying this method is that the maintenance capex remains incorrect for capex heavy companies. Take Conoco Philips (COP) for example.
The maintenance capex is negtive because the PPE % of sales applied to the sale growth is very high. Does this mean that capex has been understated where the maintenance capex was actually $19,099+$5435=$24,535 in 2009??
Please let me know if you have the answer to this.
Some Final Thoughts
So the Greenwald method is a good one and makes sense for consistent companies but won’t work if the sales growth number is greater than the capex figure.
The method isn’t perfect and still doesn’t seem to be able to determine the maintenance capital expenditure of commodity based businesses such as COP, ATW and NUE.
Am I doing something incorrectly? If so, please leave a comment. I would love to know.
September 18th, 2009 at 5:07 am
I am trying to replicate your calculations for WMT and COP – specifically the PPE as a % of Sales. Are you using the net PPE (from the balance sheet) and dividing it by the Revenues (from the income statement)?
My percentages are way off from yours. In 2004, COP had sales $136B and PPE of $50B (give or take). With the exact numbers, it generates PPE to Sales ratio of 37.2%. Not the 75.2% you have above.
How did you get that 75.2%? Are you averaging the previous 7 years of data?
September 18th, 2009 at 9:52 am
Jae Jun,
Are you going to be emailing out the new excel templates that include the Maintenance Capex calculation.
If you take the averages for COP the Maintenance Capex calculation works out. I calculated the average for the three year and five periods as per your example and it worked out to a reasonable number.
September 18th, 2009 at 10:16 am
Actually it seems I was selecting the wrong cells in excel. I was using 2002 numbers for 2005 and 2003 for 2006 and so on. But the numbers still look wrong. I’ll have to recheck it.
@G4nz0
Yes Im using net PPE/revenues
@Ryan B
I’ll be sending out the new intrinsic value model spreadsheet to anyone that bought after Oct 2008. It includes more than just a capex calculation. A full EPV valuation method as well as a summary page and many changes.
September 18th, 2009 at 12:43 pm
COP wrote off a ton of stuff in 08 and 09, that might be affecting the number pulled into the spreadsheet.
September 18th, 2009 at 1:38 pm
Unfortunately, since the number used is sales, impairments are ignored in the equation.
I’m thinking that rather than multiplying the ppe/sales ratio to the sales growth, why not just multiply that ratio to capex directly.
September 19th, 2009 at 5:10 pm
I don’t understand why you would multiply that ratio to capex. That ratio is used explicitly to find what percentage of sales is needed in PPE to support those sales, and as a result is used to find growth capEx as you’ve mentioned. Multiplying the ratio by capEx would be a misuse of the ratio I would think. Doesn’t make intuitive sense to me to use it that way. Please elaborate.
Great article btw.
Jonathan Goldberg´s last blog ..Lecture Summary – Francis Chou
September 19th, 2009 at 10:55 pm
My thought is that the ratio is really only indicating growth in sales due to the level of PPE which is why the numbers are incorrect if PPE makes up a big amount of sales.
Right now if I go through any company that has a log of tangible assets, the maintenance capex numbers will always be incorrect. So if maintenance capex is incorrect for companies like COP or NUE or other commodity based businesses, EPV will also not work.
From what I see, the calculation essentially takes away a sales figure from capex. So to me it seems like I am taking an apple and trying to subtract it with an orange.
September 20th, 2009 at 12:52 pm
I’m a little bit confused but I will try to make light of the way I understand what Greenwald is trying to show.
PPE/Sales shows the level of PPE that is required to support a given level of sales. By multiplying this by the increase in sales we are finding “Growth CapEx” which is the CapEx that is being used to support the extra sales.
Actual CapEx is made up of “Growth CapEx” and “Replacement CapEx” – so by subtracting growth capex from current year’s capex we are left with replacement capex.
Replacement CapEx is what we want to use in our calculation of EPV as we are using “no growth” cashflows to find EPV.
Jonathan Goldberg´s last blog ..Lecture Summary – Francis Chou
September 20th, 2009 at 4:24 pm
I understand what Greenwald is saying but after reading it so many times and thinking about it, I’ve come to the conclusion that it isn’t correct.
When you multiply PPE/sales to the changes in sales from the previous year, the resulting number does not equal growth capex. Capex is what goes out, sales is what comes in, and by multiplying to sales, Bruce seems to be using an income figure to say it is an expenditure. Just doesn’t make sense how it can be used as growth capex.
So as you mentioned, if PPE/sales shows the level of PPE required to support a given level of sales, multiply PPE/sales to capex in order to get maintenance capex rather than growth capex.
After going through several companies, it seems to work out better because since PPE/sales is always less than 1, it which means I’m not getting negative maintenance capex as I do when I use Greenwald’s method.
What do you think?
September 20th, 2009 at 10:54 pm
A further point I thought about was that with Greenwald’s method, my example above shows that if the change in sales is either very large compared to capex or if sales is negative, then the maintenance capex becomes negative which isn’t possible.
Even if a company loses money in a given year or does worse than the previous year, the company obviously has spent money related to growth capex.
September 21st, 2009 at 12:14 pm
I definitely see what you’re saying but to me multiplying the ratio by the change in sales definitely makes sense as growth capex. Capex had to be spent above and beyond the amount needed to maintain prior year’s sales in order to reach this new sales number.
Regarding the negative aspect… I’m not too sure. I usually just let it be a negative in my model so that I am evaluating on a consistent basis.
I would be interested in reading more information about this to really lay out the logic behind it as well as solidify any possible modifications. I don’t know anywhere else this is discussed besides Greenwald’s book however.
If you do any more on this please let me know! jgoldberg@rogers.com
Jonathan Goldberg´s last blog ..Lecture Summary – Francis Chou
September 21st, 2009 at 9:30 pm
Will do Jonathon. Maybe I’ll try emailing Bruce Greenwald and ask him directly.. He’s a professor so I’m sure his email is on his school website.
It’s also a shame that there is only a handful of websites or blogs that discuss EPV. So far I only know of you, my Value Idea and me..
September 23rd, 2009 at 7:21 pm
Yeah would be great if more people went through all the trouble we do before buying a stock!
Great idea to email Bruce. Let me know if you do and hear back.
Regarding this CapEx issue it’s definitely a tough one to get my head around. The way I see it just do what makes most logical sense for the situation (until you hear from Bruce of course!). If you get a negative number then that obviously doesn’t make sense as companies can never go with zero nevermind earning money on their maintenance capex. If the number is positive and within reasonable range of depreciation then I’d go with the zero growth capex number as it does make sense intuitively to use change in sales to ppe/sales as a proxy for the extra capex required to support the additional sales.
Now one other issue I realized that we haven’t discussed yet is the issue of a negative GROWTH capex number. This would happen when the company’s revenue decreases. This does not make intutive sense as by subtracting this negative number from current capex we are imlying that if the company maintained its level of sales it would have a greater level of capex than it does in a year of decreasing sales. I would think that a year of decreasing sales and a year of flat sales should have the same capex and it would make sense that this is by definition mainentance capex. So in either of these situations I would just use that years capex as the zero growth capex number.
Would love to hear your thoughts.
Jonathan Goldberg´s last blog ..Position Update – TSE:BUI
September 24th, 2009 at 9:25 am
That’s pretty much what I did with the spreadsheet. If the change in sales was negative, I just took that years entire capex as the maintenance capex. So no increase in sales means no growth capex.
Now I got to find Mr Greenwald’s email and ask him these questions.
You would also think that there would be someone, even among the pros and famous managers that would talk about this.. From what I’m experiencing, even the best value investor managers may not even calculate maintenance and growth capex.
November 28th, 2009 at 10:23 am
Hey Something occurred to me in relation to your heavy capital expenditures question. For COP it could be more an issue of Price volatility. It take a certain amount of asset to produce a barrel of oil that value doesn’t change if the price of oil doubles. You might try using a barrels of oil/ppe instead of sales per ppe.
November 29th, 2009 at 12:20 am
But what about non oil companies? Because I would like to know how to apply a fair calculation to all companies.