September 19, 2014
Share Buybacks Slow as Scrutiny Rises
In our most recent quarterly Corporate Buyback Scorecard, companies
struggle with high stock prices and other uses for spare cash,
By S.L. Mintz
Pierre Courduroux, CFO of Monsanto. Courtesy subject
ago, investors reflexively praised announcements of major corporate
share repurchases. But skepticism over buybacks has grown recently, as
Monsanto Co. discovered in June when it announced a $10 billion stock
repurchase plan, the largest by any company this year. The St.
Louis–based agribusiness confidently earmarked more than 13 times its
capital expenditures in fiscal 2013 to buy back stock, hoping to
double earnings per share.
buybacks rarely generate much comment beyond approval. But in
Monsanto’s recent conference call, the buyback plan triggered a flood
of questions. Analysts Kevin McCarthy at Bank of America Merrill
Lynch, Mark Gulley at BGC Financial and Joel Jackson at BMO Capital
Markets urged Monsanto chief financial officer Pierre Courduroux to
discuss the company’s motivation and expectations. How would the
buyback affect alternative uses of capital? How much growth would come
from repurchases and how much from net income? How did Monsanto settle
on its target leverage?
of questions fetched mostly routine answers. “When we voted on the
buyback, we assessed potential for growth and potential for cash
generation,” Courduroux said. “So we feel we will be able to fund the
business and growth going forward.” He left questions about credit
ratings to Standard & Poor’s, which downgraded Monsanto three notches
a few days later, to BBB+, near the lower cusp of investment grade.
S&P also reduced the company’s risk profile assessment to intermediate
No one asked
Courduroux to defend the $10 billion buyback as a sound investment of
shareholders’ capital. But Monsanto’s track record on buyback return
on investment has been decidedly subpar and lags the medians of both
the 274 companies in Institutional Investor’s Corporate Buyback
Scorecard and its peers in the materials sector. Monsanto can’t say
that two years isn’t enough time for buybacks to produce satisfactory
returns. The company ranked at 103 in the second quarter of 2013, when
it only beat the medians by narrow margins. Since then buyback returns
have gone south.
To keep tabs
on companies that spend on buyback programs, II has tracked
buyback ROI each quarter since January 2013. The Corporate Buyback
Scorecard, developed and computed by New York–based
Fortuna Advisors, pulls
back the curtain that often shielded buybacks from scrutiny.
benchmarks companies can freely spend on stock repurchases with little
accountability. The scorecard reports on stock repurchase performance
at companies in the S&P 500 that bought back shares worth more than 4
percent of their market capital over the eight quarters through June.
scorecard reveals a wide range of results. The Technology Hardware and
Equipment sector posted collective buyback ROI of nearly 34 percent,
for first place, followed by Media companies, which delivered 30.4
percent. These two sectors also retired the most market capital: 9.1
percent and 8.6 percent, respectively. By contrast, Telecommunications
Services delivered just 5.7 percent in buyback ROI, retiring 5.9
percent of capital in the process.
Notwithstanding multibillion-dollar buybacks this year at Monsanto,
Discover Financial Services, Gilead Sciences, Twenty-first Century Fox
and a handful of other companies, quarterly data reveals a definite
slowdown in the pace of buybacks. During the second quarter 29
buybacks committed some $40 billion, well short of 42 announcements
worth $93 billion in the first quarter and 55 totaling $133 billion in
2013’s fourth quarter. A year ago 68 companies promised nearly $90
billion in buybacks. By 2013 standards, Monsanto’s $10 billion program
would have warranted only seventh place, behind programs at
Apple, IBM Corp., Merck
& Co., 3M Co., Wal-Mart Stores and ?Yahoo.
attribute a slowdown in buybacks to a rise in M&A, which surpassed $2
trillion in the past year, the highest level since
pre-financial-crisis 2007. However, the use of cash to buy back shares
is a complex issue in a hot M&A market. Some companies may want to
conserve cash and borrowing power for potential M&A deals. But cash
may also attract takeover bids.
markets near their historical tops also affect the pace of buybacks.
“One of the dangers managers face is that they end up doing buybacks
when stock prices look high,” says Douglas Skinner, a professor of
accounting at the University of Chicago’s Booth School of Business.
price increases alone may not satisfy buyback appetites. Delphi
Automotive, an auto-parts supplier once based in Michigan but now
headquartered in the U.K., still has $700 million left in its latest
buyback program, which will be funded from cash flow. Despite a robust
share price gain of 25 percent that outpaced the S&P 500 by 4
percentage points from August, 22, 2013, to August 27, 2014, the
company still intends to deploy those funds. “We believe our stock
price is undervalued by any measure,” says Delphi CFO Kevin Clark,
“and therefore it is not an issue.” Clark has recent history on his
side. Delphi ranks No. 10 in current buyback ROI overall and leads the
Automobiles and Components sector.
consultation with Delphi’s investor relations and treasury
departments, Clark says that he guides buyback strategy subject to
board approval. Treasurer Brad Spiegel pulls the trigger on day-to-day
execution. “We don’t turn any decisions over to outsiders,” Clark
says. “We establish guidelines on a medium, long-term and daily basis
with respect to appetite, dollar threshold and dollar amount.”
scorecard metric, buyback effectiveness, reveals a pronounced decline
in the upside of well-timed executions. Tracked over six scorecards,
buyback effectiveness relates buyback ROI to underlying shareholder
returns. The scorecard represents those shareholder returns with a
third metric, buyback strategy.
program generates positive results when buyback ROI exceeds buyback
strategy — that is, when the repurchase program creates value above
the total return to shareholders. Companies generate positive buyback
effectiveness by repurchasing stock at levels below rising price
trends. Zero median buyback may mean that access to the kind of inside
information managers have when making investment decisions provides no
particular edge. Negative buyback effectiveness suggests that managers
are doing worse than outside investors.
scorecard shows a market-timing bonus of almost zero. A year ago
timing gave buyback ROI a shot of adrenaline, and median buyback
effectiveness approached 20 percent.
companies defied the decline in buyback effectiveness. Since Apple
announced buybacks last year, its buyback effectiveness of 34 percent
has helped fuel its buyback ROI. The Cupertino, California, company
has roared back, from next-to-last place in buyback ROI a year ago to
No. 46. Palo Alto, California’s Hewlett-Packard Co. ranks second for
buyback effectiveness and sixth overall in buyback ROI.
A year ago
San Antonio, Texas–based
Tesoro Corp.’s buyback ROI ranked
near Apple’s — and it still lags 210 companies. Poor timing
added to Tesoro’s problems. The company repurchased shares as its
stock price fell, yielding the scorecard’s worst buyback
effectiveness: –27.5 percent. All except 18 companies on the current
scorecard achieved buyback ROI in positive territory, but some 138
companies reported negative buyback effectiveness.
At the other
end of the ranking, a 117 percent buyback ROI easily put Keurig Green
Mountain, a Waterbury, Vermont–based maker of coffee brewing systems,
at the top of the list for the second consecutive scorecard. Keurig
initiated a $500 million share repurchase program in July 2012 and
reported buying 5.6 million shares in fiscal 2013 at an average price
per share of $33.37. Initial results encouraged the board to authorize
a second buyback for $1 billion, following a number of quarters in
which repurchases hovered near or below the $100 million mark.
Undeterred by a stock price that had rocketed above $100 a share,
Keurig poured $700 million into buybacks in 2014’s first quarter,
reporting that during the 39 weeks through the end of June it had paid
an average price of $102.27 for 7.7 million shares.
continued run of robust buyback ROI now rests on the introduction of
its latest, soon-to-be-released coffee brewer, dubbed Keurig 2.0.
Analysts at BofA Merrill Lynch caution about rising material costs and
hefty investment in product launches at the company. They recently
lifted earnings estimates for fiscal 2014 and 2015 but retain a
neutral outlook. If Keurig stumbles, the recent buyback program could
weigh it down.
Southwest Airlines Co. returns to the top ten, landing at No. 2 by
posting buyback ROI of 91.6 percent. Third-ranked Milpitas,
California–based SanDisk Corp. generated 73.5 percent buyback ROI.
companies lack the flexibility of fast growers like Keurig and
Southwest. Navient Corp., formed from troubled student loan servicer
Sallie Mae, dwells near the bottom of the scorecard, with dismal
buyback ROI and buyback effectiveness scores. At Navient and
elsewhere, says Janney Capital Markets analyst Sameer Gokhale,
“management generally has been poor in terms of timing buybacks.” But
Navient’s options are limited. “The other consideration is how much
cash and capital a company is generating relative to places where it
can deploy capital,” Gokhale says. If ?Wilmington, Delaware–based
Navient can find no better place to invest, buybacks are more prudent
than misguided investment in capital goods or M&A. “There is no way
for management to win,” Gokhale notes. “There is always some
constituency that feels disappointed.”
The rise in
buyback programs after the financial crisis stirred academic interest
in the phenomenon, particularly the question of whether managers make
timely buyback decisions. Buybacks are a test of the market judgment
of senior executives. Managers make few pivotal investment decisions
with more facts at hand.
from stock repurchases by 2,237 U.S. companies from 2004 through 2011,
finance professors Amy Dittmar of the Stephen M. Ross School of
Business at the University of Michigan and Laura Field of Pennsylvania
State University’s Smeal College of Business tackled the question of
timing. Their paper, “Can Managers Time the Market? Evidence Using
Repurchase Pricing Data,” crunches the prices companies report each
month on repurchased shares and average stock price data before and
Market timing does add value. “The median firm repurchases stock at a
price that is 1.8% lower than the average closing price six months
before to six months after the repurchase,” the authors conclude.
differences between companies that buy back stock frequently and those
that repurchase only when they judge market conditions to be suitable.
Frequent repurchasers generally have higher market-to-book ratios,
less volatility and narrower bid-ask spreads. Frequent repurchasers
also tend to retire more shares in a year.
Opportunistic companies display a decided edge. They repurchase
shares, on average, at prices 6 to 8 percent below average monthly
closing prices. The benefit persists, the authors say, for as long as
three years from the repurchase date.
that market timing works sits uneasily with the fact that companies
often miss buyback opportunities. “When you look, on average,
purchases go significantly down in years when the market is plummeting
and up in years when the market is doing well,” says finance professor
John Graham of Duke University’s Fuqua School of Business. “It does
not appear that companies are successfully timing repurchases of their
stock in years when it is cheap or undervalued.”
companies that embark on buybacks, Monsanto cannot guarantee results.
But at least the company has left no doubt about its intentions.
Instead of trumpeting a commitment to repurchase its shares with cash
flow at some unspecified point, it has locked in accelerated buybacks.
Over the next 12 months, Monsanto will repurchase shares in bulk worth
$6 billion, half from JPMorgan Chase & Co. and half from Goldman Sachs
Group. That’s confidence. We’ll have to wait to see if it produces the
desired results. • •
© 2014 Institutional Investor LLC.