Growth Capex: a Worked Example

A business has to keep its existing machines, vehicles and premises working or its earnings fall away. That spending is maintenance capex, and a lender deducts it before it counts any cash as available for the bank. Spending that builds something the business does not yet have is different in kind. If trading turns, the business can postpone the new site and keep earning from the old ones; it cannot postpone the conveyor that has stopped.

So growth capex sits outside the lender's core reading of cash flow and inside its reading of risk. The money is real and leaves the business, but the question it raises is not whether the existing business can service its debt. It is whether the expansion will earn enough, soon enough, to justify the debt it adds while it is being built. IAS 7, as adopted in New Zealand and as AASB 107 in Australia, encourages businesses to disclose the two kinds of spending separately for the same reason; few mid-market accounts do.

The subtraction is easy; the maintenance figure is not. A lender works from the borrower's capex schedule project by project and asks of each one: does it add capacity, products or sites the business did not have, or does it replace something that was wearing out? Then it checks the result. Maintenance well below depreciation for several years suggests replacements have been relabelled as growth, which the capex-to-depreciation ratio is designed to catch. A project that does both, such as replacing an old machine with a faster one, is usually split: the cost of a like-for-like replacement is maintenance, and only the extra is growth.

A car-wash operator with six sites, constructed for this page like every figure in it, earns EBITDA of US$5.0m, spends US$1.0m a year keeping its washes running, pays tax of US$0.6m, holds its working capital flat and owes US$10.0m. It plans two new sites costing US$3.6m, funded by a US$2.4m term loan and US$1.2m of its own cash. The sites take the year to build and earn nothing in it. Debt service rises to US$2.5m: interest of US$1.0m and principal of US$1.5m. Figures are in US$m.

The same year reads as cover to spare, as cover below one or as a business burning cash, depending only on which capex the definition takes off. None of the three is wrong; each answers a different question. The leverage path shows the shape of every expansion: debt rises at once, and the earnings that bring the multiple back down arrive over two years, on the borrower's forecast that each new site earns US$0.3m in its first full year and US$0.7m in its second. If they reach half that, the second full year reads 7.9 ÷ 5.7, or 1.39 times. The figures are the example's, not a market norm.

The difference lies in purpose, not in the asset. A new wash tunnel is maintenance at a site where it replaces a worn one and growth at a site that did not have one. The distinction also has an expiry date. Growth spending is optional only until it is contracted: once the builder is engaged and the equipment ordered, a half-finished site is a cost the business cannot walk away from without loss. A lender reading a plan therefore asks how much of the growth capex is already committed, and how much could still be stopped.

DEFINED IN ONE PARAGRAPH → · MAINTENANCE CAPEX → · LENDER'S FREE CASH FLOW →

It decides three parts of the document. The cash flow covenant: whether the definition deducts all capex, only maintenance, or capex paid from the business's own cash, as in the example, is a negotiated term and moves the ratio more than most trading surprises. The capex covenant: a lender worried about expansion may cap total spending, or allow growth spending only while leverage stays below a level. And the facility itself: growth capex is often funded by a separate tranche drawn against the project, so the lender sees each draw and the borrower's own cash is not quietly spent on bricks.

CAPEX COVENANT → · CASH FLOW ANALYSIS FOR LENDING →