Debt-Financed Share Buybacks Dwindle to Lowest Level Since 2009
(Bloomberg) -- Corporate America is backing off from a funding strategy that’s been criticized for benefiting shareholders at the expense of creditors.
As tax cuts boosted profits and cash piles grew, companies looking to charge up their stock returns with buybacks are turning less to debt markets. At the end of last year, the proportion of repurchases funded by debt fell to 14 percent, the lowest level since 2009, data compiled by JPMorgan Chase & Co. showed.
That’s good news for investors who have been urging companies to shore up their balance sheets amid an increasing risk of a recession. In Bank of America’s latest monthly survey of money managers, half of the respondents preferred corporations to use cash for debt reductions, the most in nine years.
A decade of the Federal Reserve’s efforts to hold interest rates near record lows have fueled a borrowing spree, with much of the money being funneled into buybacks. Debt-funded repurchases surged to a record 34 percent of the total in 2017 and have since fallen to less than half that level.
“Buyback executions in 2018 have been some of the highest quality of this cycle as they have been predominantly funded by cash rather than debt,” Dubravko Lakos-Bujas, JPMorgan’s head of U.S. equity strategy & global quantitative research, wrote in a note to clients. It’s “a trend we expect to persist into 2019,” he said.
The view is at odds with others who expect companies to come back to the debt market to support their equities. Brian Reynolds, a strategist at Canaccord Genuity, said earlier this month that strong demand for corporate bonds and attractive valuations after the fourth-quarter rout in equities will encourage companies to take on debt and use the proceeds to reward shareholders or pursue mergers and acquisitions.
While Lakos-Bujas agrees buybacks will stay elevated for 2019, he differs on the source of funding. It’s not necessarily that borrowing is getting more costly. At 2.02 percentage points, the yield spread between equities and bonds is half that seen in 2011, meaning the equity-to-debt swap is not as attractive. Yet with stocks yielding more, the strategy still makes economic sense.
The reason that companies are likely to refrain from debt-financed buybacks has more to do with the fact that cash is abundant. S&P 500 firms excluding financials have $1.6 trillion cash on balance sheet, with additional $1 trillion held overseas, and cash flows from operations will reach $2 trillion a year, JPMorgan estimates showed.
“The current equity carry is still significant,” Lakos-Bujas wrote. “With current valuation below the long-term average, corporates are further incentivized to commit funds for stock repurchases than balance sheet deleveraging.” Still, “we believe buybacks will remain primarily funded by cash,” he said.
S&P 500 companies will spend $800 billion on buybacks this years and $500 billion on dividends, in line with 2018, JPMorgan estimated.
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