A feature of the third-quarter earnings season in Europe was the number of large corporations reinstating share repurchase programmes. Vodafone and Diageo were prominent examples while Groupe Danone announced new plans to divert surplus cash to buying in stock and BHP Billiton announced a share buy-back on withdrawing its bid for Potash Corp. Tracking this trend, Morgan Stanley notes a doubling in 2010 of the number of companies buying back shares and the volume of transactions compared with 2009. The firm also points out that companies have a lot of firepower to put behind these repurchases. Cash has become a big portion of the corporate assets of the EuroStoxx 600 companies, accounting for 7.5% of total assets.
With profit margins back to 2005 and 2006 levels, corporations look to be in robust health. It’s just a shame they remain so reluctant to invest.
Europe is simply catching up with the US. Moody’s has calculated that cost-cutting in the recession of 2008 and subsequent resurgent earnings even in a moderate recovery since 2009 have helped US non-financial corporations build a cash hoard of nearly $1 trillion. That equates to 28% of their total outstanding debt and far exceeds their present plans for capital expenditure or dividend payouts. Cisco Systems, Microsoft and Google were each holding $30 billion of cash at the start of November, with pharmaceuticals, energy and consumer products companies also highly liquid.
Such high cash buffers have protected companies and their lenders during the recession. Now shareholders are increasing pressure on companies to run these surpluses down, as cash produces such a low return in a near-zero interest rate environment.
In the US corporations have increasingly turned to share buy-backs. The volume of buy-backs peaked in the US in 2007, at the height of the leverage bubble as companies, seduced by the mirage of endless low-cost liquidity, simply borrowed cash and passed it on to shareholders. Repurchases in 2007 amounted to $584 billion; they plummeted to less than $130 billion last year. Morgan Stanley calculates that in 2010 authorizations have risen back to $326 billion, although actual share repurchases might be under $300 billion for the year. That’s a big change.
Credit analysts at Citi see the deleveraging momentum in the US fading as profits surge. And while leverage is stable for now, with net debt at roughly 1.4 times ebitda for corporates in the S&P and 1.7 times for EuroStoxx corporations, Citi’s analysts conclude that the period of concerted improvement of credit has passed for now. Bondholders are wary of this tendency to return excess cash to shareholders through buy-backs and special dividends or higher regular dividends, leaving less earmarked to meet debt service.
While Morgan Stanley and Citi track repurchases of stock by publicly quoted companies, bankers in the US high-yield debt markets note a return of leveraged recapitalization deals whereby private equity owners have been taking advantage of healthy primary markets and low underlying rates to borrow money against corporate assets and dividend it out to themselves.
While this may be worrying for bondholders, it is no doubt even more frustrating to developed-world governments and central bankers. All this cash going to repurchase stocks is cash that companies could have chosen to invest in expanding their businesses, so boosting growth and expanding employment. But they decided not to. That betrays a profound lack of confidence in the developed-country economies. Large corporations could use this cash to fund investment at low cost. It seems they calculate that the likely return on capital investment will be just as low, if not lower.
Commentators at McKinsey argue that share buy-backs rarely create value and that the excessive concentration on short-term profits over long-term earnings is the product of a new reckless caution among company managements. Time will tell if the Federal Reserve’s policy of quantitative easing helps to boost their confidence in the months ahead. Much depends on these intangible factors of market psychology because in these circumstances simply flooding the system with more money looks rather pointless.
