REWARDS AWAIT CORPORATE AMERICA IF IT´S CANNY WITH CASH / THE FINANCIAL TIMES COMMENT & ANALYSIS

August 25, 2013 1:30 pm

 

Rewards await corporate America if it’s canny with cash

 

By John Authers

 

Cash pile picture set for shake-up as tapering nears approaches

 

US companies are paying record amounts of cash back to investors. But they are not as generous as they appear.

The scale of the flow of cash out of US corporate coffers is not in doubt. According to JPMorgan calculations, the total paid out in the 12 months to July was the highest ever.

According to JPMorgan’s Thomas Lee, corporates announced $455bn in buybacks during this period (an increase of 32 per cent on the year), while total cash return, including dividends, reached $821bn. That beat the previous record of $787bn, set on the eve of the crisis at the end of 2007. Since 2009, cumulative buybacks have totalled $1.4tn.

 

These numbers are impressive. Corporate America has disgorged a lot of cash. But US companies famously have huge piles of cash burning a hole in their balance sheets. When compared with share prices, the US dividend yield is nothing special, at 2.01 per cent.

Historically this is very low. Dividend yields exceeded 6 per cent before the last equity bull market got going in the early 1980s. The payout ratio (the proportion of profits paid out as dividends) is just above 30 per cent; it was typically above 40 per cent during the bull market of the 1980s and 1990s.

This is one of many areas where the US differs from Europe, where the tradition is to maintain a constant payout ratio, and for the actual amount of dividends to vary (while in the US treasurers pay out less but try never to announce a cut). Deutsche Bank says that in this cycle, with earnings poor, companies have responded by paying out a lot more. As a result, the payout ratio for Stoxx 600 companies has now reached 48 per cent, compared with a long-term average of 42 per cent. This should put US companies’ behaviour in context.

As for stock buybacks, many of them have been balanced by issuance of stock connected with options for executives. Companies that did this were merely avoiding a dilution of their share price, not doing anything to push prices up.

According to David Santschi of TrimTabs, which tracks stock market liquidity, buybacks have run at $2.7bn per day this year, its highest since 2007, when it reached $3.2bn per day. However, this has been skewed by the huge buyback announced by Apple, which had an exceptional cash pile. The number of companies buying back each day is 2.7, which is historically low.

 

More importantly, the number of shares on issue in the US has actually risen each month this year, according to Mr Santschi. On balance, companies have issued more shares than they have bought back. Remunerating executives still marginally trumps keeping investors happy.

The arguments about whether the US stock market is cheap or expensive will rage on – but in sum, judging by their behaviour, corporates do not find it cheap.

Thus the concerted drive to reduce the float of shares – generally referred to as “de-equitisation”, to use a term coined almost a decade ago by the Citigroup equity strategist Robert Buckland – is notable by its absence. This may seem surprising, as the trend for de-equitisation was always based in the historically cheap credit that was available in the years before the crisis. Thanks to central banks, credit is even cheaper now.

 

However, at least two elements from the last drive to de-equitisation are missing. Leveraged buyouts are notable by their absence, as investors are not wild about the returns private equity managers made during the last boom, and have not given them the same firepower. Mergers and acquisitions funded by cash or debt are increasing, but still half their pre-crisis levels, according to TrimTabs.

There are various takes on this. One is that US companies, unaccustomed to pressure from investors to raise payouts, could yet raise their yields considerably.

Another is that companies that do use cash to reduce their float will stand out in this environment, and be rewarded.

Events since tapering talk started in May suggest that the latter may turn out to be more correct. Thanks to the ingenuity of exchange traded funds, it is easily measured. PowerShares has an ETF that invests in “Buyback Achievers”, while various ETFs track companies with a strong dividend yield.

 

So far this year, the Buyback Achievers has gained 24.6 per cent. This is ahead of the S&P 500, and the sharp rise in bond yields has scarcely braked it. Meanwhile Vanguard’s High Dividend Yield ETF is up only 15.2 per cent for the year, lagging the index. It has stalled since May.

As bond yields rise, income investors grow less desperate, and no longer reward companies for big payouts. But any companies that reduce their float, showing that they believe their own stock to be cheap, are more likely to be rewarded.

And as tapering approaches, Corporate USA’s cash piles remain imposing. We will soon see if they need them.

 

Copyright The Financial Times Limited 2013