Buybacks on the Cards in Europe as Corporate Leverage Declines

  • Economic recovery spurs ‘substantial deleveraging’: JPMorgan
  • Shareholder-friendly corporate activity now a possibility

European investment-grade companies are in the middle of a deleveraging wave thanks to a self-sustaining economic recovery -- spurring hopes their cash windfall will finance shareholder-friendly activity in the months ahead, according to analysis from JPMorgan Chase & Co.

Net leverage among European corporates tracked by the bank has fallen from 3.2 times to 2.9 times over the past year, helped by low interest rates, an uptick in margins and the fastest pace of earnings growth since 2010. In particular, asset disposals have led to a halving of net leverage among oil and gas companies.

JPMorgan Chase & Co.

However, the decrease in indebtedness won’t necessarily benefit bond investors, according to JPMorgan. European businesses now have substantial firepower to go on a buying spree or increase share buybacks, as the proportion of earnings paid out to shareholders has fallen over the past year.

“Based on the U.S. experience during this cycle, they may soon decide to spend their windfall on acquisitions or on supporting their stock prices,” analysts including Matthew Bailey wrote in a recent note. “As a result, we do not expect net leverage to decline much further.”

JPMorgan Chase & Co.

Better-than-expected economic data has also improved other leverage metrics, such as the interest-coverage ratio, a measure of corporate vulnerability to rising rates. Earnings relative to debt expenses for 200 investment-grade issuers climbed to 12.7 times in the second quarter, close to a post-crisis high, according to the analysts.

Low rates are likely to spur more refinancing activity in order to reduce interest costs further, according to JPMorgan -- some measure of comfort for bond investors should the flurry of corporate activity in favor of equity investors take root.

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