While there has been much debate over the likely success of the Obama administration’s fiscal stimulus package, there seems to be little doubt that the sheer scale of the plan means that a number of companies are set to benefit in some form from increased federal spending. Of the $787 billion earmarked by Congress, 37 per cent will go on tax relief and 18 per cent on state and local fiscal relief with the remaining 45 per cent consisting of federal aid. This represents a $354 billion increase in federal spending over the next few years, with much of this going into energy (including alternatives), transportation, healthcare, education, defence and security.
The argument that over the longer-term stimulus packages are generally impotent derives from the concept of “crowding out”. This holds that the government will need to issue more debt to finance its increased spending or to cover the shortfall from reduced taxation revenues. This debt will then “crowd out” private investment as savers and investors favour the supposedly safer government debt over corporate bond issues. The net result is a contraction in economic activity as private investment and consumption shrinks. The counter-argument to this is the multiplier effect, which considers how much the money supply increases in response to either an increase in government spending or a reduction in taxation. Essentially this is a trickle-down theory which posits that as money is pumped into the economy, the wealth spreads and is spent on consumption goods, thus multiplying the impact of the policy action.
What most people would agree upon is that any kind of fiscal stimulus or tax break typically gives a short-term shot in the arm to the economy. Of course, this overlooks the theory of rational expectations, whereby the public at large begins to fret over the long-term budgetary implications of the government’s fiscal policy and acts accordingly, reducing consumption and increasing saving. Nonetheless, the short-term impact of looser fiscal policy is that it usually results in a boost to economic growth unless there are other exceptional factors at play. Beyond this, the simple fact is that even if you don’t believe in the benefits of fiscal stimuli for the overall economy, the benefit to companies that participate in increased government budgets are pretty clear.
With this in mind, it is worth drilling down into the specific areas likely to see the benefit of increased government spending. Obvious candidates can be drawn from the Industrials sector, where increased infrastructure spending will likely benefit companies such as Foster Wheeler (FWLT), Shaw Group (SGR) and KBR Inc (KBR). Of these names, the most interesting is KBR Inc, where 60 per cent of 2008 revenues were derived from the Government & Infrastructure division with much of the remainder coming from its Energy & Chemicals business. While a good proportion of government spending currently comes from logistical support services for US armed forces in the Middle East, the company appears well-positioned to benefit from increased domestic infrastructure spending as it seeks to transition its business in tandem with the troop withdrawal from Iraq. KBR appears to be attractively valued, trading on a 0.48x share price multiple to intrinsic value and with approximately $7 of cash per share on the balance sheet (and zero debt), or around 50 per cent of its market capitalisation.
Another area that is likely to be a beneficiary of elevated government spending levels is IT Services. While a number of the bigger diversified names in the group will likely see some incremental revenue flow, including the likes of Accenture (ACN) and Hewlett-Packard (HPQ), a better pure-play on the theme could be a name like SAIC Inc (SAI). The company is well-positioned to benefit from increased federal spend across a wide range of projects in areas such as security, health, energy and the environment through its support for IT infrastructure projects in these areas. While the stock is not particularly cheap relative to its growth outlook, it has proven to be resilient in the equity market sell-off and remains a defensive name at a volatile time for equities overall as an asset class.
Disclaimer: The views expressed are the opinions of the writer and whilst believed reliable may differ from the views of Butterfield Bank (Cayman) Limited. The Bank accepts no liability for errors or actions taken on the basis of this information.