Record-Low Yields Should Spur Buybacks, Tilson Says
U.S. companies should use record low interest rates to issue debt and buy back stock to boost per- share earnings, according to hedge-fund manager Whitney Tilson.
Those with high credit ratings and enough cash are ideal candidates to sell bonds and cut their dividends to raise money for repurchasing their own equities, said Tilson, whose Tilson Focus Fund beat 96 percent of peers in the past five years, according to data compiled by Bloomberg.
Free cash flow generated by Standard & Poor’s 500 Index companies, excluding financial firms, represented 6.8 percent of stock prices last month, the most since 1960 versus debt yields, according to data compiled by Zurich-based Credit Suisse Group AG. Johnson & Johnson and International Business Machines Corp. sold bonds at record low rates in August.
“There’s an incredible window right now for some of the world’s best companies,” Tilson, the co-founder of New York- based T2 Partners LLC, said in an interview yesterday.
Corporate debt rates fell to a record low last month, when a Bank of America-Merrill Lynch index measuring U.S. bond yields touched 3.74 percent. Cash that companies, excluding financial firms, could use for buybacks represents 10.1 percent of total assets, according to data compiled by Bloomberg. That’s the highest since at least 2000.
Home Depot, Dell
Home Depot Inc., Dell Inc. and Berkshire Hathaway Inc.’s Burlington Northern Santa Fe LLC led the busiest day for U.S. corporate bond issuance in more than seven months. Companies sold $15.4 billion of the debt as yields fell to 3.83 percent yesterday, according to Bank of America Merrill Lynch’s U.S. Corporate Master index. Hewlett-Packard Co. and American Express Co. lead borrowers marketing at least $14.7 billion of corporate bonds today, according to data compiled by Bloomberg.
Corporations whose shares are undervalued by at least 20 percent should repurchase stock, while everyone else should return cash to shareholders with a dividend, Tilson said. More U.S. stocks are paying dividends that exceed the average bond yield than any time in at least 15 years as profits rise at the fastest pace in two decades.
IBM’s 1 percent, three-year notes sold last month have the lowest coupon of the more than 3,400 securities in the Barclays Capital U.S. Corporate Index of investment-grade company debt. The world’s biggest computer-services provider added $8 billion to its stock-repurchase plan in April, boosting the total to $10 billion, and increased its dividend 18 percent.
‘Plenty of Opportunity’
Shares of the Armonk, New York-based company trade for 11.9 times earnings for the past 12 months, compared with 14.5 for the S&P 500. The stock jumped 56 percent in 2009 and has retreated 3.8 percent since Dec. 31.
“You could say bonds are safer, and stocks could go down,” said Tilson, who organizes the Value Investing Congress twice a year, in New York and Los Angeles. “The problem is the people buying the bonds are long-term investors and should have long investment goals. We think there’s still plenty of opportunity” for stocks, he added.
Investors are snapping up bonds as a haven amid concern the U.S. economy will contract for the second time in three years. Money has been removed from U.S. mutual funds that invest domestically for four straight months, while debt funds haven’t experienced an outflow since December 2008, according to data compiled by the Investment Company Institute, a Washington-based trade group.
Yields on 10-year U.S. Treasuries fell to 2.42 percent last week. When they sank to 2.0352 percent in December 2008, it was the lowest in records going back to 1953.
“Deflation and depression are the overwhelming cultural fears,” James Paulsen, chief investment strategist at Minneapolis-based Wells Capital Management, which manages $342 billion, wrote in a Sept. 3 note. “Investors seem content with zero return money market funds since ‘return of capital’ is paramount to ‘return on capital.’”
A record plunge in U.S. home sales, a surge in jobless claims and an unexpected drop in manufacturing overshadowed better-than-expected corporate profits this year. While the world’s largest economy started growing in the third quarter of 2009, the rate slipped to 1.6 percent last quarter from 3.7 percent in the first quarter, adding to concern the U.S. will enter a recession.
Buybacks in the U.S. are accelerating. Companies authorized $88 billion more last quarter than the first three months of the year, putting 2010 on track for the fourth-largest year, according to Birinyi Associates Inc., a Westport, Connecticut- based research and investment firm.
The S&P 500 is trading at 14.4 times earnings from the past year, 30 percent lower than the 20-year average, according to data compiled by Bloomberg.
“High-quality stocks have never been cheaper in my investment career,” said Tilson, 43. “Investors have been shunning the highest-quality stocks. They’re investing like they’re going to die tomorrow.”
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