Lack Of Interest

2/6/2012


Money is cheap.

Indeed, the cost of money — interest rates — remains near record lows and promises to stay low for at least the next three years if the Federal Reserve Board has its way. 

Those low rates have had a huge impact on the amount of interest corporate America pays on its debt. Also helping are dramatically lower funding costs for banks and other financial concerns, reflecting the Federal Reserve's efforts to keep overnight borrowing rates in the banking system near 0%. For the 12 months ended Sept. 30, 2011, companies in the S&P 500 Index paid $174 billion in interest expense, the lowest amount since the 12-month period ended June 1998.

To give you an idea as to how much interest rates have declined, S&P 500 corporations paid that interest on a debt load of nearly $4.6 trillion, or roughly twice the debt burden at the end of the second quarter of 1998.

To be sure, companies have not necessarily gone on a borrowing spree because of the low cost of money. Corporate long-term debt levels for S&P 500 companies are 25% higher than they were a decade ago but have fallen 25% since the second quarter of 2008. And because of the big drop in interest rates, interest payments have fallen even faster, declining 63% over the same time period.

Lower interest payments mean higher profits and more cash for a host of corporate actions, including dividend hikes and stock buybacks. Not coincidently, year-over-year dividends paid by S&P 500 companies rose more than 16% in 2011 to $240 billion, the highest amount since 2008. S&P reports that dividend increases for all the companies it monitors reached more than $50 billion in 2011, up 89% from 2010. S&P reported 1,953 positive payout actions in 2011, up 13% from 2010 and the highest since the 2,513 positive dividend actions in 2007. Only 101 companies cut or omitted dividends, down 30% from 2010 and the fewest negative dividend actions since 2006.

Dollars spent on stock buybacks have been growing, too. Companies in the S&P 500 bought back more than $400 billion worth of stock in the 12-month period ending September 2011, the highest amount in three years.

The bottom line is that investors seeking a bullish story for stocks need look no further than balance sheets. With nearly $2 trillion in cash and manageable debt loads, corporate balance sheets are in their best shape in years. Record corporate profits in 2012, aided by lower interest payments, should only help matters. Those strong corporate balance sheets and improving income statements should fund more buybacks and dividend increases. The percentage of corporate profits being paid out in dividends (known as the payout ratio) is near 28%, well below the 20-year average of 40%. Said differently, corporate America could boost dividends an aggregate 43% in 2012, and the payout ratio would only expand to its 20-year average.

The table below lists four recommended stocks that meet the following criteria:

• All have reduced their interest payments by at least 10% over the last three years.

• All have long-term debt equaling less than 30% of total capital.

• All have reduced their outstanding share count by at least 5% over the last three years.

• All have been aggressively boosting their dividends.

LESS INTEREST, FEWER SHARES, MORE DIVIDENDS
3-Year Change
Company (Price; Ticker)
Div.
($)
Yield
(%)
52-Week Price Range
Interest
Expense
(%)
Share
Count
(%)
L-T Debt
as % of
Capital
Chevron ($103; CVX)
3.24
3.1
110.99
-
86.68
(32)
(6)
7
Exxon Mobil ($84; XOM)
1.88
2.2
88.23
-
67.03
(17)
(12)
5
UnitedHealth ($52; UNH)
0.65
1.3
54.18
-
40.9
(12)
(17)
27
Visa ($101; V)
0.88
0.9
104.2
-
70.45
(78)
(9)
0

Three stocks are reviewed below.

Energy giant Chevron ($103, CVX) has seen its interest payments decline 32% over the last three years. Strong profits and lower rates have helped fuel stock buybacks and dividend hikes. Chevron's share count is 6% lower than it was three years ago, while its quarterly dividend has grown nearly 40% since the first quarter of 2008. Chevron, attractively valued at eight times the 2012 profit consensus, is a Focus List Buy and a Long-Term Buy.


Managed-care concern UnitedHealth Group ($52; UNH) has knocked down its interest payments 12% over the last three years while boosting the quarterly dividend more than fivefold since the first quarter of 2010. The company has funneled some of the interest savings into stock buybacks — outstanding shares have fallen 17% over the last three years. The falling share count has helped fuel solid per-share-earnings growth — 2011 per-share earnings of $4.73 were 60% above 2008 results. UnitedHealth has beaten the consensus earnings estimate in each of the last four quarters, and the current 2012 estimate of $4.79 per share — a modest 1% advance over 2011 results — may prove conservative. UnitedHealth Group is rated Buy and Long-Term Buy.


Visa ($101; V), which operates an electronic payment network, has an exceptionally clean balance sheet with no long-term debt. The elimination of long-term debt in recent years has all but eliminated Visa's interest expense, leaving the firm more money to buy back shares — the share count has fallen 9% in the last three years — and boost dividends. Visa's quarterly dividend has more than doubled since 2009. The consensus estimate calls for nearly 18% growth in per-share profits in the fiscal year ending September 2012. The stock is not cheap at 17 times the fiscal 2012 estimate of $5.84 but warrants a premium valuation given its strong growth prospects. Visa is a Buy and Long-Term Buy. 


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