JUNE 16, 2015
As Stocks Edge Higher, Buyback Programs Get Riskier
Companies like GE and Apple continue to repurchase shares in large
numbers. But these programs may get riskier.
By S.L. Mintz
PHOTO CREDIT: INSTITUTIONAL INVESTOR
Few companies “go big or go home” with more gusto than Fairfield,
Connecticut’s General Electric. By announcing a $50 billion stock
buyback, the global industrial conglomerate joins yet another elite
club. Only Cupertino, California–based
buyback program, now pegged at an astounding $200 billion, exceeds the
scale GE has proposed. GE’s buyback commitment is five times larger
than its previous stock repurchases over the eight quarters through
the end of March. Subject to price fluctuations, GE expects to retire
up to 20 percent of its shares by the end of 2018.
The GE buyback is clearly tied to the company’s recent strategic
decision to sell its finance unit, GE Capital, a move that will
eliminate a big source of profits. Generating earnings per share will
be a challenge despite the agreement to acquire Levallois-Perret,
France–based power generation and distribution giant Alstom for $13.5
billion. The buyback, says analyst Steven Winoker at New York money
manager AllianceBernstein, “is meant to offset dilution associated
with the exit of GE Capital.”
GE highlights a stock buyback trend that has not significantly eased
even as pricier shares make so-called capital return programs, which
combine repurchases and dividend payouts, riskier. In the eight
quarters through the end of March, some 276 companies in the Standard
& Poor’s 500 repurchased 4 percent or more of their market
capitalization. In the first quarter of 2015, buybacks approached $144
billion, a brisk pace, if just behind the $158 billion in the
first quarter of
2014. Since Institutional Investor initiated the
Scorecard in 2013, companies meeting the 4 percent
threshold have diverted $1.2 trillion to buybacks, or a median $128
billion per quarter.
“S&P firms know that annual revenue growth is slowing at this late
stage in the cycle,” says John Blank, the chief equity strategist at
Chicago-based Zacks Investment Research. Slower growth prospects
combined with a strengthening dollar, growing piles of cash and low
borrowing rates contribute to the case for buybacks. “Buybacks are the
easy way to build up EPS when fundamentals are so soft,” he says.
“It’s probably a signal of both weak operating earnings growth and,
somewhat paradoxically, weak revenue growth performance.” The heart of
that paradox is when buyback volume exceeds earnings.
Although buybacks represent major corporate investments, their
announcements seldom stir much of a debate about accountability for
outcomes. This absence led to the creation of the Quarterly Buyback
Scorecard, developed by and computed for Institutional Investor
by Fortuna Advisors using data from S&P Capital IQ. Quarterly
scorecards look back two years to analyze whether buybacks rewarded
shareholders, or punished them, during that span. “It’s a very
legitimate question to ask,” says chief financial officer Dennis
Kelleher at CF Industries Holdings, a Deerfield, Illinois–based
fertilizer company, which has used buybacks to trim its market capital
by 23 percent according to the latest scorecard.
Companies continue to spend heavily to buy back shares. Nineteen
companies each repurchased more than $10 billion worth of stock in
this scorecard. The latest GE initiative, scheduled to be completed by
2017, exceeds its 2014 earnings by more than three to one and its 2014
capital expenditures by a similar margin. GE’s buyback performance,
however, has been lackluster over the past two years. Its repurchase
program generated a 4.6 percent return on investment, putting it at
No. 209 in 2015’s first quarter, down from No. 180 in the first
quarter a year ago. In the first quarter of 2013, GE ranked 82nd, with
an ROI of 26 percent.
Volume, timing and motives differentiate individual buyback programs.
Some companies want to absorb excess shares in the wake of
divestitures or shares issued to facilitate acquisitions. Cincinnati
supermarket chain Kroger Co. has a long record of using cash flow from
its stores to repurchase shares ever since it issued new shares in
1999 to merge with the Fred Meyer chain. “We started a buyback program
to reduce dilution,” Kroger chief financial officer J. Michael
Schlotman told Institutional Investor in 2014. At 71 percent
ROI, Kroger currently ranks No. 3 in buyback ROI.
served to placate activists like Carl Icahn and others who saw few
better uses for the company’s huge amount of cash. The most recent
scorecard shows that those buybacks have produced stellar results. Two
years ago Apple’s buyback ROI was in the basement. But in this
scorecard the company records the sixth-best ROI, at 54 percent.
Apple’s buyback ROI exceeded its buyback strategy, a proxy for total
return to shareholders, by 12 percent.
Buybacks often beget more buybacks. Apple recently announced a plan to
boost its capital return program from $130 billion to $200 billion by
Not everyone has performed as well as Apple, with an uncertain market
taking its toll. In the first-quarter scorecard, median two-year
buyback ROI for the S&P 500, in which companies retired at least 4
percent of market capital, ticked down from the previous quarter by
one percentage point, to 16.5 percent. A year ago median buyback ROI
for the S&P buyback cohort was 25.2 percent, off its peak of 26.8
percent at the end of 2013.
Current scorecard leader Dallas-based Southwest Airlines repurchased
shares in all eight quarters, from a low of $39 million in the fourth
quarter of 2013 to $315 million the following quarter. All told,
Southwest bought back shares worth $1.7 billion, or 5.7 percent of its
market capital. The investment nearly doubled in value, to $3.3
No. 2 on this quarter’s scorecard is Orlando, Florida–based Darden
Restaurants, which owns and operates more than 1,500 family-style
restaurants. Darden, which has been the target of hedge fund activist
campaigns, deployed a portion of the proceeds from the sale of its Red
Lobster chain to buy back shares. An accelerated repurchase program
took shares off the hands of two institutional investors, Goldman
Sachs and Wells Fargo Bank. Buyback ROI at Darden surpassed 82
Some buybacks, like Darden’s, are intended to mollify activists,
whereas others grease the wheels of strategic alliances. For example,
buybacks helped Bethlehem, Pennsylvania, drug distributor
AmerisourceBergen Corp. ink a purchasing pact with Deerfield,
Illinois, drug retailer Walgreens Boots Alliance. Terms of the deal
allowed Walgreens to buy 7 percent of AmerisourceBergen plus warrants
amounting to 16 percent of the drugstore company’s outstanding shares,
exercisable between March 2016 and September 2017. Anticipating
potential dilution when warrants are exercised, notes analyst Ann
Hynes at Mizuho Securities, AmerisourceBergen began repurchasing
shares. So far, the company’s timing has been excellent, and it ranks
No. 5 on the current scorecard.
Three other health care equipment and services companies join
AmerisourceBergen at the top of the scorecard: Irvine, California,
heart valve manufacturer Edwards Lifesciences (No. 4) and managed care
health insurers Anthem (No. 7), based in Indianapolis, and Humana (No.
8), headquartered in Louisville, Kentucky. Humana announced a $2
billion buyback in September 2014 after reporting a dip in net profit
as benefit costs increased.
Atlanta’s Delta Air Lines (No. 9) and Cambridge, Massachusetts,
biotech Biogen (No. 10) fill out the top tier.
At the other end of the ranking are two capital goods companies, a
media company and a consumer durables and apparel retailer. Four
energy companies ended up in the basement as well, hurt by the slump
in oil prices. In dead-last place Houston-based oil and gas equipment
supplier National Oilwell Varco saw its repurchased shares lose 62
percent. One spot above, London-based Noble Corp., a contract oil and
gas driller, lost 52 percent. By contrast, Tesoro Corp., a San
Antonio, Texas–based refiner, ranks at No. 11 with a buyback ROI of 51
For the past two years, six sectors come in near the top of their
buyback ROI ranges and 14 are near their bottoms, with a handful —
telecom services, utilities, and consumer durables and apparel —
somewhere in the middle. Technology hardware and equipment,
transportation, and food and staples retailing still show strength.
But with so many sectors near their lows, the S&P 500 in the latest
scorecard languishes near the bottom of its ROI range.
In this scorecard a median company retired shares equivalent to 6.7
percent of its market capital. Buybacks at 13 retired more than a
fifth of market capital. One of the latter is CF Industries, at No.
47, which bests all but two of 15 companies in the materials sector,
beating the median ROI in its peer group by two to one.
Buyback strategy at CF is part of a rigorous approach in managing a
global competitor in the manufacturing and distribution of
nitrogen-based fertilizer products. “We really think of this as a
machine in trying to grow cash generation through nitrogen capacity
per share,” Kelleher says.
A string of buybacks in combination with new revenues from
acquisitions tested CF’s metric. CF now generates 143 tons of nitrogen
capacity per 1,000 shares of stock, a three-fold increase since 2010.
A market climate favorable to buybacks can override earlier guidance
from the company. CF had warned analysts to anticipate a pause in
buybacks during the first quarter of 2015. When conditions
unexpectedly favored buybacks in that period, CF returned to the
market. “We took the view that we had a good handle on cash flow, knew
where we were going and that it made sense to be in the market after
saying we would not be in the market,” Kelleher says.
No matter what motivates companies, buybacks share a common effect: As
the number of shares falls, EPS tends to rise. In the current
scorecard Fortuna analyzed this relationship by matching buyback ROI
quintiles with changes in EPS. Overall, the data confirms what we
expected: Buyback ROI and EPS generally move in tandem. The top
tranche in median buyback ROI recorded the top median percentage
change in EPS. Lower tranches behaved similarly, with the fifth
tranche recording the lowest median percentage change in EPS.
That’s a general observation that applies to companies in aggregate.
Results for individual businesses are more difficult to predict.
Houston’s Cameron International Corp., a supplier of measurement and
control equipment for oil and gas producers, repurchased almost a
fourth of its shares, a higher percentage than any other company in
the current ranking, over the eight quarters through the end of March.
Nonetheless, its EPS slid by more than 57 percent as buyback ROI took
a pounding, falling by 23 percent.
Grouping companies in buyback ROI quintiles highlighted similar
reductions in share count. However, the median change in EPS for each
group fell sharply descending through the quintiles. In the top
buyback ROI quintile, a median company reduced share count by 6
percent and posted a 36 percent increase in EPS and 40 percent buyback
ROI. The bottom quintile did not feature aggressive buybacks as a
rule. The median company in that group bought back 6 percent of its
shares but posted an 11 percent decline in EPS and an 8 percent slide
in buyback ROI. Instead of signaling good news, buybacks at a fifth of
the companies signaled that they would be generating lower EPS in the
Across the board, companies hoping to improve market performance or
EPS with buybacks, rather than by growing the business, will often
find the going rough. As Fortuna CEO Gregory Milano concludes: “Our
study showed that EPS growth from buybacks added about half the value
versus EPS growth from operations.” Operations still matter.
© 2015 Institutional Investor LLC.