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Tossing Capex Over the Side

THE WALL STREET JOURNAL

The president-elect may want to build stuff, but many others are losing their taste for it.

Shares in Chesapeake Energy jumped more than a quarter Monday after announcing it would slash its 2009 and 2010 capital expenditure budget by almost 40%. Chesapeake is facing the reality of contracting energy demand and credit availability. Several of its peers, from Royal Dutch Shell to Apache Corp., have also delayed new projects until energy demand, and prices, stabilize.

Investors’ jubilant reaction to Chesapeake’s cutbacks shows how attitudes have changed rapidly. Forget earnings growth; it’s all about survival. Just as banks hoarded cash, industrial companies further down the financing chain are doing the same. Dow Chemical’s stock leapt 7.5% Monday even as it announced large cutbacks to headcount and capex, in part to protect its dividend.

In one respect, such scaling back is reassuring. With the cost of capital up, but project returns assumptions probably flat or down, the spread – or profit – has been squeezed. Growth becomes uneconomic, and capacity must be rationalized.

That doesn’t make it any less painful for everyone involved – or any less risky for investors. Tobias Levkovich, Citigroup’s chief U.S. equity strategist, reckons capex tends to follow credit conditions with a nine-month lag based on historical trends. The last Senior Loan Officers survey, in October, saw another big tightening in business lending, so capex cutbacks could continue well into 2009.

With regard to falling payrolls, they have a clear link to consumer spending. But they also impact capex: Why upgrade a PC that’s no longer used? Investors switching away from consumer stocks and tempted by low earnings multiples in capital goods and materials sectors should think twice.

Write to Liam Denning at [email protected]

WSJ ARTICLE

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