December 10, 2007

Maintenance capex calculation

I discussed about maintenance capex and its relation with Free cash flow. To recap

Free cash flow = Net earnings + depreciation – maintenance capex

And free cash flow is the money the owner of business can take out or re-invest in the business.

Maintenance capex however does not have a precise formulae. That does not mean you cannot calculate it. But as you can see, if valuation is based on free cash flow which itself is based on an imprecise measure such as maintenance capex, it cannot be precise in itself.

Valuation depends on free cash flow, project growth rates , terminal value and the discount rates. All these are estimates and hence valuation is itself an estimate. That is the reason I find it assuming when analysts give reports where they give precise valuation targets and on top of that even the duration (next one year !!) when the target would be met.

So, coming back to maintenance capex, how do I estimate it? let me warn you at the outset. My approach is self developed, imprecise and only roughly right.

I will use my
valuation template to explain my approach

Worksheet – anal – In this worksheet I fill up the sales, depreciation, wcap etc. On line 26, I calculate the additional capex (additional fixed asset and Wcap for the year). Line 27 is capex as % of sales. This gives me a capex trend (total) for a period of time for the business. I then use this trend to estimate the maintenance capex.

For ex: if the business has an asset turn (on average) of 2, then I would assume capex as 2.5% of sales

Sales = 100
Asset = 50
Inflation increase in sales = 5
Corresponding asset required = 2.5 (2.5% of sales)

If the business is asset heavy (commodity industry) then the maintenance capex as % of sales is high.

If the asset turn is 1, then maintenance capex would be roughly 5% of sales. You can compare this % with depreciation as a % of sales to see if both are roughly equal.

You may find some errors in my worksheet and I plan to load an updated version soon. I don’t use these worksheet very frequently now. After using these worksheets for several years, I am now in a position where I can look at the numbers and estimate if the company looks roughly undervalued. A lot of companies don’t pass that test and are rejected outright. If a company passes that filter, I fill up the excel and go through the entire exercise (which is not very precise in itself)

I have loaded a few samples in the
google groups. If you go through this exercise yourself several times, you will see patterns and it will be faster for you too.

In addition to the above excel, please have a look at the excel – Quantitative calculation – worksheet : Maintenance capex to see the relationship between Sales, Asset turns, Maintenance capex and ROC.

Ofcourse you can have a counter argument – who the hell wants to go through such an elaborate exercise to value a company? Don’t I have better things to do in life :)


value investor india said...

Hi Rohit...

Take a look at this website

Some info that is not available anywhere is available here on a pay per use the AR of Savita Chemicals for Rs.100

It is maintained by CMIE and is quite comprehensive


Rohit Chauhan said...

hi bhavesh
thanks for website. it is quite useful to get missing ARs.
you can also download free AR from the edifar website. however a lot of times, AR and other documents are missing on the EDIFAR database.

Anonymous said...

You are doing a great job sharing information. It is greatly helpful for a newbie like me. I have one question on your gujarat gas spreadsheet. In Sheet "Anal" line no 27, you multiply capex by a factor(0.085 in this case). Can you please explain how you arrived at that number ?


Rohit Chauhan said...

Hi anonymous

5% is generally the prescribed depreciation for fixed assets. other assets like computers have a much higher depreciation . i have taken a rough estimate of 8.5% of fixed asset as wcap is negative in case of gujarat gas.
this 8.5% is a bit conservative. 5-6% of asset or 2.5-3% of sales should be ok


Anonymous said...

Hi Rohit,

One silly question!

If a commodity based company is having net profit margin of around 5% - it means FCF is equal to depreciation. Or this business will generate (recover) total FCF equals to the remaining value of fix asset only?

Your comments!

Prashant Dubey