Stock Buybacks Surge as Companies Borrow for Share Repurchases
Record-low interest rates are stoking the biggest increase in U.S. share buybacks ever.
American companies announced $55.9 billion in repurchases since June, data compiled by Birinyi Associates Inc. show. That adds to $93.5 billion in the second quarter and $108.3 billion during the first three months of the year, compared with $125 billion in all of 2009. Corporations are using debt to pay for buybacks after the average yield on U.S. investment grade bonds fell to an all-time low of 3.70 percent last month, data from London-based Barclays Plc show.
Companies from Microsoft Corp. to PepsiCo Inc. and Hewlett- Packard Co. are taking advantage of low-cost financing, purchasing their stock to boost per-share earnings at a time when the Standard & Poor’s 500 Index trades at a 24 percent discount to its average valuation since 1954. At the same time, choosing buybacks may show executives are too concerned about the economy to invest in new projects or make acquisitions.
“It’s so cheap to do it now in the bond market: issue debt, fix their cost of capital, then shrink the number of shares outstanding,” said James Swanson, chief investment strategist at Boston-based MFS Investment Management, which oversees about $197 billion. “The markets are almost calling for them to do it.”
U.S. companies have announced $258 billion in buybacks so far this year, compared with $52 billion in the first three quarters of 2009, according to data compiled by Birinyi. The almost fivefold increase is the largest for any January-to- September period since at least 2000, when the Westport, Connecticut-based research firm started tracking the data.
Buybacks let firms boost per-share profits by reducing their equity base and may indicate executives find their stock undervalued. Evidence that businesses are parting with their record cash shows concern the economy will slip into its second recession in three years is diminishing.
“Levering a balance sheet is a good idea if you want to expand your company,” said Hayes Miller, the Boston-based head of asset allocation in North America at Baring Asset Management, which manages about $44 billion. “You don’t do that unless you feel secure about 2011. It may just be the corporate outlook for 2011 is better than you would gather from economic news.”
Microsoft will sell debt to pay for dividends and stock buybacks, a person familiar with the matter said last week. The Redmond, Washington-based software maker could issue as much as $6 billion in debt without putting its credit rating at risk, according to data compiled by Bloomberg.
Peter Wootton, a Microsoft spokesman, declined to comment.
PepsiCo in Purchase, New York, has sold $4.25 billion of bonds in 2010, according to data compiled by Bloomberg. The company said in January that it aimed to use debt proceeds to finance the takeover of two bottlers and for other corporate purposes that may include buybacks.
The company authorized a plan on March 15 to repurchase as much as $15 billion in stock over three years. With the acquisition now complete, PepsiCo is able to increase buybacks that were postponed during the negotiations, according to spokesman Dave DeCecco.
The maker of Doritos and Mountain Dew predicted on July 20 that earnings per share will grow 11 percent to 13 percent. Zurich-based Credit Suisse Group AG estimated 3 to 4 percentage points of that will be from share repurchases. Buybacks may total $4.4 billion in 2010, Pepsi said on July 20. That’s 4.3 percent of its average market value this year.
HP boosted short- and long-term borrowing by $4.18 billion between January and July, Bloomberg data show. The week before the Palo Alto, California-based company sold $3 billion in bonds on Sept. 8, it added $10 billion to its plan for share repurchases, an increase to the $4.9 billion already authorized. Buybacks are among potential uses for the debt proceeds, according to a Sept. 9 filing. Anything listed in a government filing is a possibility, said Gina Tyler, a HP spokeswoman.
“Oftentimes, you’ll see a debt issuance almost simultaneously with a share buyback announcement,” said Guy Lebas, chief fixed-income strategist and economist at Janney Montgomery Scott LLC in Philadelphia. “Even though there’s no explicit connection, it only takes a little bit of common sense to realize the relationship.”
Completing the plan would reduce HP’s stock outstanding by 14 percent, based on the average price in 2010. The largest personal-computer maker said Aug. 19 that it bought back 55 million shares in the fiscal third quarter, prompting analysts at Susquehanna Financial Group LLP to raise the profit estimate for the following period by 1 cent to $1.27 a share.
U.S. companies are boosting share buybacks as economic growth weakens from 5 percent in the fourth quarter of 2009, the biggest increase since 2006. Gross domestic product may rise at an annual pace of 1.9 percent in the three months ended Sept. 30, according to the median estimate in a Bloomberg survey of 63 economists.
“If that’s the best use of companies’ cash, then that really doesn’t tell a great story about how corporations are feeling for the near future,” said John Canally, an investment strategist and economist at LPL Financial Corp., which oversees $276.9 billion in Boston. “Things aren’t terrible, but they aren’t great either.”
Announced buybacks this year are about 70 percent below the record $863 billion pledged in 2007, Birinyi data show. While the S&P 500 trades at 12.4 times forecast earnings for the next 12 months, compared with a 56-year average of 16.4 times reported profit, low valuations haven’t been enough to spur an equity rally.
The S&P 500 rose 1.5 percent to 1,142.71 today, the highest level since May 13. It’s up 2.5 percent in 2010 and down 6.1 percent from its April high. The index gained 1.5 percent last week amid speculation Microsoft will sell debt for share buybacks and after Oracle Corp. beat earnings estimates.
Decreasing price-earnings ratios and record low interest rates are spurring executives to raise money in credit markets. U.S. companies have sold $83.4 billion in new stock in 2010, the lowest level for the first nine months of any year since 2005, based on data compiled by Bloomberg. At the same time, companies sold $786 billion in both high-yield and investment-grade U.S.- dollar denominated debt after $1.23 trillion last year.
The Federal Reserve has held its target rate for overnight loans between banks at zero to 0.25 percent since cutting it in December 2008. The lowest benchmark borrowing costs in the U.S. and the Fed’s purchase of bonds pushed the average yield on U.S. investment grade debt to 3.70 percent last month, Barclays says.
As yields sank, the relative return for holding dividend- paying stocks grew. Last month, more companies in the S&P 500 paid dividends that exceeded the average interest rate on corporate bonds than any time in at least 15 years, Bloomberg data show.
The level of debt outstanding among American companies outside the financial industry increased 1 percent between April and the end of June to an all-time high of $7.26 trillion, a second quarterly advance, according to Federal Reserve data released on Sept. 17.
While industrial and consumer companies are paying down loans, computer makers, energy producers and utilities in the S&P 500 are boosting borrowings to record levels, according to data compiled by Bloomberg. Technology makers in the S&P 500 owe $123 billion, and oil and power companies had long- and short- term debt of $204 billion and $324 billion at the end of the second quarter.
Free Cash Flow
Per-share free cash flow in the S&P 500, or earnings minus capital expenses, rose to $102.01 this quarter, the highest level since at least 2000, according to Bloomberg data. Excluding banks, brokerages and insurance companies, S&P 500 companies generated $682.2 billion in cash and near-cash items last quarter, the data show.
“Corporations are finally feeling a little bit more comfortable and realizing that their own shares are cheap and financing is very cheap, so why not issue some debt and buy back stock?” said David Kelly, who helps oversee about $445 billion as chief market strategist for JPMorgan Funds in New York. “That’s a great way of distributing cash to shareholders and boosting stock prices.”