Is Growth Always Good?

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Investors are in love with growth. If a company is not growing, most investors are not interested. As a result, most senior-level managers like growth too. If not for a higher stock price, then CEOs want to grow for the sake of controlling a larger amount of assets.

However, growth may not always be a good thing. Growth can either add or destroy value depending on the returns it produces for the company. For example, growth at a company like FTI Consulting is almost always a good thing; its only assets are people, which tend to earn more revenue for the firm than they are paid. In addition, non-unionized people can more be disposed of more easily than most other assets. On the other hand, capital-intensive industries generally struggle to earn a high enough return on investment to justify rapid growth.

Old economy stalwarts

Alcoa (NYSE: AA) is an old-economy stalwart that is trying its best to grow in a mature industry. It continues to invest in new refineries in emerging markets and is revamping some of its older ones in order to lower its manufacturing costs. Alcoa produced a record amount of alumina in 2010 as a recovery in the global economy led to renewed demand. In addition, its joint venture in Saudi Arabia will become operational later this year. The company seems to be growing at a decent pace despite the state of its industry.

Century Aluminum (NASDAQ: CENX) is another player in this capital-intensive industry. As with most manufacturers, Century maintains high fixed costs which lead to outsized profits when output prices rise and outsized losses when output prices fall. However, with other metals's prices on the upswing, a renewed surge in demand for aluminum may be on the horizon. However, Century's production capacity is relatively small, which puts it at a disadvantage in an industry that rewards size. However, Century has significantly added to its asset based over the last decade in an effort to grow out of its size disadvantage.

Finally, Allegheny Technologies (NYSE: ATI) is a large and diversified supplier of metals to a wide array of industries. The company has been on the upswing recently as its alloys are used in unconventional oil & gas extraction techniques that are gaining wider adoption. In addition, the company recently acquired Ladish, a metals supplier to the aerospace industry. Allegheny seeks to benefit from the increase in global air traffic as well as the increase in titanium used to build next-generation aircraft.

Destroyers of value

Each of the three aforementioned companies have grown tangible assets at a faster rate than they have grown sales over the last decade. Alcoa grew tangible assets at an annual rate of 4.29% while growing sales at only 2.34% per year. For Century Aluminum, the numbers are 11.82% and 7.44%, respectively. For Allegheny Technologies, 11.82% and 11.74%.

This presents a major problem for growth enthusiasts. It costs money to grow assets, so the company should demand a decent return in exchange for buying additional assets. However, with sales growth unable to exceed the growth in assets, these companies clearly are not earning their cost of capital. This is painfully obvious in their low pre-tax returns on tangible invested assets.

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Over the last ten years, only Alcoa earned a positive return on tangible invested assets -- averaging 6.28%.

Shareholders would be better served if these companies used excess cash to simply buy a broad-based index fund or returned cash to shareholders through dividends. But they will continue to acquire assets that do not provide adequate returns because that is what shareholders demand.


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