In May, Atlanta-based Delta Air Lines unveiled its intention to wrap up a $5 billion buyback program. Why, in this age of continual buyback announcements, is this surprising? Stock repurchases routinely garner a lot of investor attention when they debut, as companies boast of the return of excess cash to shareholders and the upticks in earnings per share that they believe will result. But share-repurchase initiatives often then fade away, like old soldiers. In fact, many companies never fully spend the cash allocated to buy back shares, rolling it into new programs that they then announce with great fanfare.
Buyback Scorecard The S&P 500 as Stock Repurchasers Best & Worst Companies Industry Comparisons
Delta management obviously thought that investors would find merit in the actual completion of a share-repurchase program. In the first seven months following the authorization of the initiative, the airline spent $2.2 billion on 48 million shares. Delta intends to repurchase the last shares by May 2017, six months ahead of schedule, including $375 million in accelerated share buybacks in the current quarter.
News that Delta will complete the buyback program, in tandem with its third 50 percent dividend hike since 2013, nudged its stock up 5.4 percent before it settled to $43.10 on May 19, a 3.6 percent gain over the last closing price before the buyback and dividend hike were announced.
Delta shareholders should applaud, says airlines analyst Duane Pfennigwerth at ISI Evercore in New York. “Large airlines competing on the size of their capital-return programs as opposed to the size of their aircraft-order books is a relatively new, very healthy and underappreciated attribute of the U.S. airline industry,” he notes.
Delta isn’t alone. Another company that is now explicitly talking about the completion of its buyback plan: Union, New Jersey’s Bed Bath & Beyond. The home-goods chain’s chief financial officer, Susan Lattmann, said recently that the company intends to complete a $2.5 billion buyback by fiscal 2020, subject to business and market conditions — a relatively long, four-year end date, but a firmer commitment than most other companies offer.
The kind of emphasis that Delta and Bed Bath & Beyond put on fulfilling their buyback promises quietly suggests that the capital-return strategy is under some stress. Critics have questioned the practice of artificially boosting earning per share by reducing the number of shares; or the effect of buybacks on capital investment, R&D and growth; or the practice of rewarding exiting shareholders with repurchases at the expense of long-term investors.
And as investments, buybacks have suffered recently. For the first time since Institutional Investor introduced its Corporate Buyback Scorecard in November 2012, the overall median return on investment from the strategy — what we call buyback ROI — has gone negative. The bull market no longer lifts most buybacks, according to the latest Buyback Scorecard, which covers the quarter ended on March 31, 2016, and includes data going back two years. The scorecard was developed and the results calculated for Institutional Investor by New York–based Fortuna Advisors using data from S&P Capital IQ.
The Buyback Scorecard provides a framework for analyzing the effectiveness of some of the largest investments many companies make. Were managers sound judges of the outlook for their own companies when they repurchased shares? In the name of returning cash to investors, did long-term shareholders subsidize returns of exiting shareholders? Did managers throw good money after bad in buyback programs, foregoing other, more productive opportunities in the process? Which companies put buybacks to the best possible use?
In early 2013 companies with positive buyback ROI outnumbered those with negative returns by a factor of nine to one. On the current scorecard barely 40 percent of companies report positive buyback ROI. Since early 2013 median buyback ROI has fallen from 28.8 percent to –5.3 percent. In other words, buybacks have been money-losing investments for most companies in the scorecard.
This performance decline hasn’t killed off enthusiasm for buybacks. Capital distributions clearly favor buybacks over dividends. Across all 24 sectors surveyed, median buybacks surpassed median payouts by 2.8 to one — a dollar of dividends to three dollars of buybacks. At Delta cash allocated to buybacks exceeded dividends by six to one.
Delta continues to have success with its buybacks, delivering a 9 percent return on investment to shareholders over eight quarters through March. The airline outperformed median buyback ROI in the transportation sector by more than 15 percentage points and the median for all scorecard companies by upwards of 14 percentage points.
Still, the case for buybacks is often confused. It’s pretty simple math to say that EPS will grow when fewer shares have a claim on net income; but it’s also misleading, notes Tim Koller, a partner in McKinsey & Co.’s corporate finance practice in New York. “You should not be doing buybacks just to increase earnings per share,” he warns. Koller and co-authors Obi Ezekoye and Ankit Mittal spell out their case in a new report, “How Share Repurchases Boost Earnings Without Improving Returns.”
The McKinsey paper argues that since Congress opened the door to buybacks in 1982, companies have increasingly favored repurchases over dividends. Buybacks are more flexible than dividends, which shareholders expect to see in perpetuity. McKinsey also argues that there’s little evidence that growth in buybacks is harming overall capital investment, which continues to run just above the growth of gross domestic product. One big reason: The increasing dominance of sectors, like technology and health care, generating profits from intellectual property, which tend to be less capital intensive than the overall corporate sector, and thus generate more free cash flow.
Koller wouldn’t discard buybacks as a tool for distributing surplus cash, only the misconception that increases to EPS have as much market impact as growth in revenues or profit margins. “The market is smart enough to distinguish the difference,” Koller says. Investors reward companies for generating EPS not for how they distribute it. Attractive investments eventually return more value than buybacks, he adds, but the effect on financial statements won’t show up as fast as the EPS bump that may follow.
Share repurchases may boost EPS but that doesn’t mean they improve buyback ROI, which is a way of measuring whether or not a company has earned adequate return on its repurchased shares over a specific period of time. “The lack of correlation between EPS and buyback ROI is a reason to hold companies that have manufactured EPS through the use of buybacks accountable,” says Joseph Theriault, Fortuna’s vice president of research.
Whatever motivated them to repurchase shares, the 305 Standard & Poor’s 500 companies ranked in the scorecard spent $1.1 trillion over eight quarters through March on share repurchases. After retreating in late 2015, buybacks resumed their robust pace during the brutal start for stocks in 2016.
Three full years of Buyback Scorecards allow us to view buyback programs from a variety of perspectives: over time, by varying sectors, volume, percentage of market cap retired, buyback ROI relative to underlying ROI and different quintile groupings.
In the current scorecard Cupertino, California, tech giant Apple leads all companies in buyback volume. During the first quarter alone, Apple poured $7 billion into buybacks, capping an unprecedented buyback program. During the past eight quarters, the company repurchases exceeded $70 billion, retiring 12 percent of its market capitalization. Despite the scale of its program, it ranked No. 165 on the scorecard with a buyback ROI of –7.2 percent.
Apple appears unfazed. Citing confidence in its outlook, the company’s board hiked its repurchase authorization by $35 billion, to $175 billion, in April. Two years ago, when its stock was flying high, the company resisted activist investor Carl Icahn’s call for big buybacks. Now that it has seen iPhone sales fall for the first time, it’s pressing ahead.
This quarterly Buyback Scorecard includes ten sectors that rack up positive buyback ROI, against 14 that show negative returns. Consumer Services buybacks fare best, led by Orlando, Florida–based Darden Restaurants and Oak Brook, Illinois–based McDonald’s Corp. As a group, this sector enjoyed an 11 percent return on its buyback investments. Consumer Durables and Apparel companies, led by Beaverton, Oregon’s sports-apparel giant Nike, posted an 8.6 percent buyback ROI.
Still, even the best returns look tepid compared to earlier buyback ROIs. Real Estate companies recorded 32.6 percent in buyback ROI in the first quarter of 2013. Behind ten sectors on the latest scorecard, Real Estate, ranked 11th out of 24 sectors, saw buyback returns decline by –0.5 percent. A year ago five sectors boasted median buyback ROI of over 30 percent: Technology Hardware and Equipment, Health Care Equipment and Services, Food and Staples Retailing, Real Estate and Retailing. This time all five fall below top buyback ROI of 11 percent posted by Consumer Services. Of the five only three, Retailing (5.9 percent), Food and Staples Retailing (5.4 percent) and Health Care Equipment and Services (5.2 percent) eked out a positive buyback return.
Moreover, weak sectors have drifted further down. Market volatility shredded buyback ROI in Diversified Financials hardest. The group’s buyback ROI fell to –18 percent. Energy and Automobiles and Components both declined more than 10 percent. A year ago, energy and utilities recorded positive buyback ROI.
As expected, the beleaguered Energy sector’s buyback ROI has been pummeled. El Dorado, Arkansas’ oil exploration and production company Murphy Oil Corp. paid upwards of $50 a share to retire stock, now changing hands closer to $30, leading to a punishing buyback ROI of –58.2 percent, and a ranking just one place above the bottom.
“Timing is always sort of lacking for E&Ps,” says John Herrlin Jr., who heads Société Générale Corporate & Investment Banking’s oil-and-gas research effort in New York. “You have to be systematic [about buybacks] rather than episodic,” he explains. “But in this industry free cash flow is mostly episodic.”
Refiners have had an easier time. Buybacks at Tesoro Corp., based in San Antonio, produced ROI in excess of 14 percent. “Product prices tend to be sticky,” Herrlin says. “They go down slower than feedstock prices.”
Sectors alone don’t determine buyback ROI. Companies in Semiconductors and Semiconductor Equipment occupy places on the best and worst lists. Santa Clara, California–based graphics chips maker Nvidia Corp. delivers the second-best buyback ROI, powered by record revenue in gaming platforms and related sectors. Micron Technology, conversely, is dead last. The Boise, Idaho, memory chip maker’s management has blamed weakness in the PC market, seasonality and the timing of product launches.
A skidding stock price has reduced the value of Micron shares by more than 31 percent. Poor timing caused a further decline of nearly 43 percent in buyback ROI. The disparity highlights what we call buyback effectiveness, which measures buyback ROI relative to underlying total return, labeled buyback strategy on the scorecard. All 24 sectors post negative buyback effectiveness, ranging from –0.3 percent in Telecommunications Services to –16.3 percent for companies in the Technology Hardware and Equipment sector.
Only 45 companies delivered positive buyback effectiveness, topped by Springdale, Arkansas-based Tyson Foods’ 35 percent. The latest scorecard reports that the meat processor spent $1.3 billion on buybacks, reducing market cap by 5.2 percent.
Bringing up the rear in buyback effectiveness: New York’s E*Trade Financial Corp. at –52.1 percent.
The median company on the scorecard reduced its market capital by 7.8 percent. At the upper end, Houston’s Quanta Services, which provides outsourced services to broadband, electric power, gas pipeline and electric power companies, trimmed market capital by nearly half — closely trailed by five companies that shed about one third or more of their market capital.
Critics of buybacks continue to hammer aggressive repurchase programs. “If you purchase shares and your buyback ROI is negative or below what the equity is delivering, you’ve rewarded the exiting shareholder financed by the ongoing shareholders,” says Jeff McCutcheon, a co-founder of Jacksonville, Florida, consulting firm Board Advisory.
In a February report to the United Nations Secretary General’s High-Level Panel on Access to Medicines, a team of researchers led by University of Massachusetts economist William Lazonick, a longtime critic of the strategy, takes aim at a key misconception: that shareholders as the sole risk-takers deserve first claim on all corporate profits allocated to buybacks.
Taxpayers, Lazonick says, assume some of the risk, not least by annually funding the National Institutes of Health, which supports life-sciences research, to the tune of $32 billion a year. Workers with employment uncertainty have earned a competing claim on profits. He argues that the first step “to restore stable and equitable growth” is to ban pharmaceuticals companies from repurchasing stock.
Critics like Lazonick face an uphill battle. Both boards and shareholders favor buybacks, which have grown into a flexible and increasingly prominent component of capital strategies. Many more will follow, leaving the question: How many will really be completed? And how will they perform?
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