Where The Cash Goes

7/7/2014


Nonfinancial companies in the S&P 500 Index held $1.34 trillion in cash and marketable securities at the end of the first quarter, up 7% from a year earlier, according to FactSet Research. The two sectors with highest cash balances also generated the strongest cash growth, with technology up 11% and health care up 15%.

In some ways, the two sectors have chosen different paths for spending that cash. Both rank among the most active sectors for deals. But health-care companies have aggressively boosted capital spending, while tech firms keep ramping stock
repurchases.

In the following paragraphs, we investigate trends in the three major prongs of capital deployment.

Dividends and stock buybacks

Most S&P 500 companies remain committed to dividends. The median S&P 500 dividend hike was 11% in the first six months of 2014, as shown below. The energy sector led all 10 major sectors with median growth of 19%.

TOP SECTORS FOR DIVIDEND GROWTH
The following five S&P 500 sectors have delivered the strongest median dividend growth through the end of June.
S&P 500 Sector
No. Of Dividend
Payers
(% Of Sector)
Net Positive
Dividend
Actions
Median
Dividend
Growth
(%)
Median
Yield
(%)
Consumer discretionary
64
(75)
36
18
1.9
Energy
70
(91)
21
19
1.5
Industrials
61
(95)
33
14
1.6
Materials
29
(97)
10
11
1.6
Technology
44
(67)
20
11
1.9
S&P 500 total 
422
(84)
222
11
2.0

Recommended stocks that raised their quarterly dividends by at least 20% this year: Alaska Air Group ($98; ALK), Macy's ($59; M), Qualcomm ($80; QCOM), and Schlumberger ($118; SLB).    

Source: Standard & Poor's.

Index stock buybacks jumped 59% in the March quarter. Technology paced the growth, spending more than twice as much as any other sector. Tech companies represented seven of the 12 most active share repurchasers for the quarter.

Investors may be starting to sour on the strategy. After all, buybacks become an increasingly expensive choice as stock prices climb. Share repurchases could also be viewed as a sign of weakness, indicating management's reluctance to address the less certain, but ultimately more important, need for operational growth.

The 20 biggest share repurchasers in the S&P 500 for the March quarter have an average year-to-date total return of 6%, lagging the index's average return of 10%. Moreover, three of the four sectors that spent the most on buybacks in both the March quarter and in the past year — consumer discretionary, financials, and industrials — trail the S&P 500's year-to-date return by at least two percentage points.

Notable exceptions are Apple ($94; AAPL), with a total return of 18% this year, and Cisco Systems ($25; CSCO), 14%. Both ranked among the six biggest spenders on their own shares in the March quarter. And both earn Value scores of at least 85, suggesting their shares are still cheap.

Apple spent $17.97 billion on stock buybacks in the March quarter; aside from IBM ($186; IBM), no other S&P 500 company spent that much in the past year. In the 12 months ended March, Apple shaved 7% from its share count. Cisco has lowered its outstanding shares 12% in the past four years, paying an average price of about $20.50 per share. Apple is a Buy and a Long-Term Buy. Cisco is a Long-Term Buy.

TOP SECTORS FOR STOCK BUYBACKS
The five S&P 500 sectors presented below have been the most active for stock buybacks in the March quarter and over the past year.
-- March2014 Quarter --
12 Months Ended March
S&P 500 Sector
Total
Buybacks
($Billions)
Change
From Year-
Ago Period
Total
Buybacks
($Billions)
Change
From Year-
Ago Period
5-Year
Total
($Billions)
Consumer discretionary
18.6
21
73.5
17
282.7
Financials
18.3
40
63.8
13
203.9
Health care
15.8
(6)
61.0
(18)
267.6
Industrials
22.0
145
66.8
85
176.5
Technology
49.2
180
153.0
92
443.2
S&P 500 total
159.2
59
534.9
29
1,844.5

Recommended stocks that ranked in the top 20 for stock buybacks in the March quarter: first-place Apple ($94; AAPL) and sixth-place Cisco Systems ($25; CSCO).    

Source: Standard & Poor's.

Capital expenditures

As if sensing investors' waning enthusiasm for stock buybacks, companies have ramped capital expenditures, which include outlays for property, plants, and equipment.

Capital spending rose 6% in the first quarter of 2014 for nonfinancial S&P 500 companies, says FactSet, the strongest gain since the September 2012 quarter. Growth amounted to less than 1.5% in each of the prior four quarters. Analysts now expect capital spending to advance 7% for the year, up from their original target of 1.5%.

Including S&P 500 financials, median growth for capital investments was 8% for the March quarter and 6% over the past 12 months, as shown in the nearby table. The strongest growth came from health care, with about three-quarters of companies increasing their spending.

Google ($591; GOOGL) is well known for its acquisitions, spending more than $18.5 billion on deals in the past two-and-a-half years. It also plowed $8.50 billion into capital expenditures during the 12 months ended March, up 120%. Data-center construction remains Google's top investment priority to ensure it can handle spikes in demand. Other investments focus on production equipment and real estate. The duration of Google's elevated capital spending is uncertain, but the company is unlikely to run into any cash constraints. Operating cash flow has risen in 18 of the last 19 quarters, and the balance sheet contains net cash of $53 billion ($78 per share). Google is a Focus List Buy and a Long-Term Buy.

TOP SECTORS FOR CAPITAL EXPENDITURES
The following five S&P 500 sectors have the highest median growth for capital spending over the past year.
------- March Quarter -------
---- 12 Months Ended March ----
S&P 500 Sector
Median
Cap-Ex
Growth
(%)
% Of Sector
Constituents
Growing
Median
Cap-Ex
Growth
(%)
% Of Sector
Constituents
Growing
Consumer discretionary
5
60
9
67
Consumer staples
7
63
10
70
Financials
12
28
11
31
Health care
23
78
13
72
Materials
13
60
9
70
S&P 500 median
8
49
6
53
Recommended stocks that raised capital spending by more than 20% in both the latest quarter and over the past year: Ameriprise Financial ($122; AMP), B/E Aerospace ($94; BEAV), EMC ($27; EMC), Google ($591; GOOGL), and Packaging Corp. ($72; PKG).

Mergers & acquisitions

The value of globally announced deals (including mergers, acquisitions, and spinoffs) climbed 73% to $1.77 trillion in the first half of 2014, according to Thomson Reuters, the highest volume since 2007 and strongest growth since 1998. The number of M&A announcements was up slightly from the year-earlier period. The average acquisition premium for U.S. targets was 32%, down from 37% in the year-ago period, indicating that executives showed some constraint after the market's 2013 surge.

ANNOUNCED DEALS
Global announcements of mergers and acqusitions surged 73% to $1,771 billion in deal value in the first half of 2014. U.S. companies were targeted in deals valued at $756 billion, up 70%. However, average premiums for takeover announcements declined in the U.S. and globally. Premium values represent the announced takeover price relative to the target's average price in the four weeks prior to the announcement.
---- Total M&A Value ($Millions) ----
--- Average Premium (%) ---
Period
Global
U.S.
Global
U.S.
First half 2014
1,771,749
756,086
25.5
32.2
First half 2013
1,025,103
444,977
28.8
37.4
2013
2,393,298
1,037,774
28.4
35.7
2012
2,542,704
932,174
30.9
40.3
2011
2,545,300
980,221
29.5
37.0
2010
2,396,689
776,486
28.8
38.1
2009
1,980,347
719,362
31.5
33.0
Source: Thomson Reuters.

Note that this data include rejected takeover bids. A leading 18% of all global deals announced in the first half came from the health-care sector, followed by 13% from media and entertainment, due in part to the inclusion of both Comcast's ($54; CMCSa) $70.68 billion bid for Time Warner Cable ($148; TWC) and Charter Communications' ($160; CHTR) competing bid of $62.58 billion. Comcast is a Buy and a Long-Term Buy.

Companies are using their elevated share prices to help fund deals. Through late April, the percentage of announced deals involving just stock was at its highest level since 2003, according to Dealogic. The percentage of cash-only deals was at its lowest since 2001.

Investors are usually skeptical of acquisitions. But acquirers' shares rose 72% of the time following M&A announcements of more than $1 billion in the March quarter, according to Thomson Reuters. That compares to 60% of the time in the December quarter and the seven-year average of 50%.

United Rentals ($107; URI) saw its shares outperform by 4% the day after agreeing to acquire National Pump for $780 million in March. Shares of SanDisk ($105; SNDK) outperformed by 3.6% after the company said it would purchase Fusion-io for roughly $1.1 billion in June. For other deals, concerns about protracted regulatory battles tempered enthusiasm. Shares of both Comcast and AT&T ($35; T) fell after they announced big acquisitions in the consolidating pay-TV sector. SanDisk and United Rentals are rated Focus List Buy and Long-Term Buy. AT&T is rated A (above average).

TOP INDUSTRIES FOR M&A
The industry groups listed below experienced the strongest merger-and-acquisition interest for the six months ended June, based on announced deal values. Takeover data is classified by targeted company rather than by suitor.
--------- % Of Total Announced M&A Value ---------
--------------- Full Year ---------------
Target Industry
First Half
Of 2014
2013
2012
2011
Announced U.S. M&A
Energy and power
14
14
19
25
Financials
6
5
9
14
Health care
22
12
17
16
Technology
10
10
7
10
Media and entertainment
24
7
6
4
Announced global M&A
Energy and power
12
15
18
20
Financials
11
10
13
14
Health care
18
9
8
8
Media and entertainment
13
6
5
5
Real estate
9
14
11
9
Source: Thomson Reuters.

Conclusion

Cash is cheap, interest rates low, and share prices elevated — just the recipe for corporate executives to recover their appetites for risk. With that in mind, it will be interesting to see if stock buybacks slowed in the June quarter, given:

• The surge in acquisitions.

• Shifting investor attitudes that favor higher capital expenditures.

• The recent underperformance of stocks and sectors with the most aggressive share repurchases.

Fewer buybacks could become a blessing, especially if that cash goes toward capital spending. Increased capital investment could create a virtuous cycle, jump-starting the economy and sparking even more spending.

 


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