Capex is a promise, depreciation is the bill

The shares traded at 498.00 this morning, -1.80% on the session. I want to write about the least discussed consequence of the capital spending cycle, which is what it does to reported profit three and four years out.

The bit that gets skipped

When a company spends heavily on infrastructure, the cash leaves immediately and the cost appears gradually. Depreciation spreads it over the assumed useful life of the asset. That is ordinary accounting, and for most of corporate history it was unremarkable.

It becomes interesting when the spending is very large relative to the earnings base and the useful life is genuinely uncertain. Both apply here.

Why useful life is the whole argument

Stretch the assumed life and the annual charge falls, reported profit rises, and nothing about the business has changed. Shorten it and the reverse. Companies do revise these assumptions, disclose them properly, and the market usually notices late.

The questions worth asking:

• What life is being assumed for the equipment, and has it moved
• How much of the spend is buildings, which genuinely last decades, versus equipment that may not
• What happens to the charge when today's spending finishes ramping

Where I come out

Long, and the reason is unglamorous. The operating cash flow here is large enough that even an aggressive step-up in the depreciation charge is absorbable without the business becoming a different one. That is not true of everyone spending at this pace, which is precisely why I would rather own the balance sheet that can carry it.

The risk in a capex cycle is not the spending. It is owning the company that has to keep spending without the cash flow to fund it.

What would change my mind

A downward revision to useful life assumptions, or capital spending that keeps climbing while the revenue it was supposed to produce does not. The second is the one that would worry me more, because it usually arrives quietly, one quarter at a time, and each individual quarter has an explanation.