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Buyback Haters About to Get a Glimpse of the World They Sought

Buyback Haters About to Get a Glimpse of the World They Sought

(Bloomberg) -- For American companies under pressure to conserve cash, share buybacks are a luxury they can no longer afford.

So say analysts studying balance sheets and earnings estimates. It’s also the view that led eight major U.S. banks to halt the practice last week. More companies are expected to follow suit, say strategists at Evercore ISI. Worst-case scenario: if the outbreak lingers until the year-end, 99% of U.S. firms will have to reduce or suspend buybacks, the firm’s head of portfolio strategy said.

The trend highlights a predicament for equity investors used to companies swooping into the market any time it sags. While repurchases have put bottoms in routs in the past, they’re at risk of drying up in times of crisis.

“The total level of buybacks will come down significantly,” said Dennis Debusschere, head of portfolio strategy at Evercore. “This will be bad. Later in the cycle, when earnings growth tends to peak out, you have less earnings growth and less margin expansion, you tend to rely more on buybacks as a driver of total returns.”

Buyback Haters About to Get a Glimpse of the World They Sought

As the virus took its toll, U.S. companies, whose willingness to repurchase shares gets credit in some circles for fueling the 11-year bull market while being pilloried elsewhere as waste, have turned their attention to essentials, such as their balance sheets.

The biggest U.S. airlines, which last decade spent 96% of their free cash flow repurchasing shares, are now awaiting $58 billion in grants and loans. Eight banks, including JPMorgan Chase & Co. and Bank of America Corp., said they will stop buying back their own shares through the second quarter, instead focusing on supporting clients and the nation during the epidemic.

With more companies joining Apple Inc. to Microsoft Corp. in slashing sales forecasts, and as credit stress builds, views on buybacks may shift. Corporate America’s cash is draining at the fastest rate in decades, with balances at S&P 500 companies excluding financial firms having fallen 11% in the past 12 months, according to data compiled by Goldman Sachs.

That doesn’t mean companies are running out of cash. At 15% of total assets, the level is higher than the historic average of 7%, Goldman data showed. But it could mean companies prefer to use their money elsewhere.

“Buybacks have been crucial struts of support for new money into equities as outflows have persisted for eight of the last 10 years,” Tobias Levkovich, Citigroup Inc.‘s chief U.S. equity strategist, said in a note. “Thus a likely drop now of 30% is a significant change to the trend.”

Firms were scaling back their announced buybacks even before the global pandemic. U.S. companies announced $122 billion of share repurchases in January and February, data compiled by Birinyi Associates Inc. show, the biggest drop to start a year since 2009. Debusschere estimates that share the reduction in shares outstanding caused by repurchases will contribute 0.5% to the S&P’s per-share earnings this year, down from a 3.5% projection in December.

Buyback Haters About to Get a Glimpse of the World They Sought

“There will be a potential for a lot of those buybacks to come offline,” said Mike Stritch, chief investment officer of BMO Wealth Management. “If share buybacks are drying up, it’s clearly indicative of a challenging operating environment. No doubt some of those decisions are already a piece of the missing support for the market in the past couple of weeks.”

The health crisis is already souring strategists’ earnings estimates, and news about buyback cancellations could make it even worse. Lower share counts from buybacks added 4.4 percentage points to stocks’ per-share profits in 2019, Evercore data show. Without buybacks, forward EPS growth could be trimmed by 250 basis points, a drop that has historically corresponded to a 1 point decline in forward price-earnings multiples, Goldman Sachs’s data last year showed.

“I don’t think this is a time when you should be looking at your excess liquidity and thinking, I’ll buy back stocks,” Jim Caron, portfolio manager of global fixed income at Morgan Stanley Investment Management, said by phone. “This is normal and predictable in times of stress.”

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