Cash-rich US companies may take cautious approach to ramping up share buybacks

Corporate America is flush with cash but shareholders should not expect to see a deluge of capital returned to them just yet.

Having slashed their share buyback programs in 2020 as liquidity became king, low borrowing costs and recovering revenues have left S&P 500 companies with near record-levels of cash that could be returned to investors.

Whereas dividends rose for the ninth consecutive year, buybacks were on track to total just $570.75 billion in 2020 after the first nine months of the year, a 25.9% drop from the 2019 total of $728.74 billion and well short of the $806.41 billion record year in 2018, according to S&P Dow Jones Indices.

However, the growth is expected to be gradual rather than an explosion, with buybacks not expected to return to the record levels of 2018 this year.

As the pandemic struck, buybacks by S&P 500 companies sank to $89.66 billion in the second quarter of 2020, the lowest level since the first quarter of 2012. And while the volume recovered to $101.79 billion in the third quarter, that still represented the second-weakest quarterly total since the first quarter of 2013.

"Companies have tiptoed back into the buyback market, seeking shares to cover employee options being exercised and prevent dilution," noted Howard Silverblatt, senior index analyst at S&P Dow Jones Indices who expects an upturn in discretionary buybacks in 2021 as the economy recovers, though ruled out a return to the 2018 level until 2022 at the earliest.

Financing buybacks is not a problem. Holdings of cash and cash equivalents among S&P 500 companies — excluding financials, real estate, utilities and transportation — totaled $1.882 trillion at the end of the third quarter of 2020, just below the record of $1.892 trillion in the previous quarter and 23.8% higher than at the start of the year.

Low borrowing costs and extensive refinancing have left companies in a better position to service their debts than before the crisis, while a recovering economy and the prospect of a major stimulus bill by the new Democratic administration has put companies in a good position to spend.

Big buyers of shares coming back to the market

The volume of buybacks is increasingly driven by the top 20 stocks in the index, which accounted for 77.4% of the third-quarter total. This was up from just 9.6% in the third quarter of 2019 and an average of 24.9% over the previous five years.Intel Corp., The Procter & Gamble Co. and L3Harris Technologies Inc. all restarted their buyback programs in the third quarter, having put their foot on the brakes at the height of the uncertainty.

Meanwhile, the cash-rich big tech companies never stopped buying shares. Led by the buyback king Apple Inc., the information technology sector accounted for 48.9% of total buybacks by S&P 500 companies in the third quarter, up from 28% a year earlier. Communication services, which includes Alphabet Inc. and Facebook Inc., was the next biggest sector at 17% — up from 6.3% in the third quarter of 2019.

Other sectors have been slower to recover. Financials, a sector that had stood alongside IT as the driver of buybacks before COVID-19, saw its share of the S&P 500 total slump to 11.9% in the third quarter, down from 27.2% a year earlier.

The Federal Reserve forced big banks to stop buying back shares as part of its stress tests in June 2020, but as of the first quarter of 2021 banks will be able to resume the practice though at a limited rate.

However, some investors suggest that an immediate return to large scale buybacks could be a bad look for sectors that have been supported by extensive monetary and fiscal expenditure. "Certain sectors received ample help from government," Christopher Rossbach, chief investment officer of asset manager J. Stern & Co., said in an interview, noting, "there has to be a very cautious approach to capital return when lack of capital was the problem."

A surge in buybacks would also risk poking the eye of the dragon as a new administration begins its term in Washington. U.S. President Joe Biden has been a vocal critic of so-called shareholder capitalism, whereby a company's profits are returned to shareholders rather than reinvested in the business or distributed among workers through pay rises, while Democrat senators such as Elizabeth Warren have proposed banning share buybacks outright.

"Companies are not going to want to provoke a reaction but they will come back unless we have a regulatory hold back," Michael Kelly, global head of multi-asset at PineBridge Investments, said in an interview. "They'll just keep steadily growing, I don't think they're going to surge any time soon."

Capital spending on the up

Buybacks are not the only options for businesses. Capital expenditure is picking up too.

Having tanked by 6.6% in the month of April, new orders of capital goods excluding aircraft reached record levels in both October and November, having climbed 8.3% in seven months to $71.04 billion, some 6.8% higher than a year earlier. The measurement of purchases of assets such as machinery, tools and buildings is a closely watched indicator of capex in the manufacturing sector.

Capital goods and building material sectors also stand to gain from Biden's proposed $2 trillion infrastructure plan, according to S&P Global Ratings.

But such is the structural shift in the American economy that if corporate America does significantly spur capital spending, it is likely to be driven by tech companies rather than the old manufacturing industries.

According to Sean Darby, global chief equity strategist at Jefferies, investment intentions could improve under the new administration, having suffered in recent years as a result of the trade dispute between the U.S. and China, with the notable exception of software companies, which have plowed cash into data centers.

"I don't think the IT investment cycle stops but there is a very good chance that we have a few industries — such as autos and telecoms — where spending resurges to grow above trend. Furthermore, the green/renewables could see the momentum snowballing as companies become incentivized to follow government initiatives," Darby said.

The bountiful availability of cash may restart mergers & acquisitions industry which stalled during the pandemic. The value of deals in the U.S. fell 30.5% in 2020 to $852.86 billion, according to S&P Global Market Intelligence data.

Rossbach expects the pro-cyclicality of M&A to result in a revival in 2021 but noted that much of corporate America is already largely consolidated.

"If you can't buy anything then you're going to return it and I think you'll continue to see that," Rossbach said, noting, "we'll see ongoing share buybacks and we'll start to see more cash return through dividends, and I think that is a really important aspect for investors."