Fitch: Buybacks Still Pressuring IG Corporate Profiles
The capital allocation strategies of many U.S. investment-grade corporate borrowers have become notably more shareholder-friendly over the past year, as an increasing number of debt-financed share buyback programs have been initiated.
Fitch Ratings believes that the uncertain global macro outlook and sluggish capital investment trends this year may again lead investment-grade companies across a number of sectors to consider more aggressive shareholder-friendly actions, particularly as equity valuations once again come under pressure.
Since the beginning of 2011, there have been 12 negative rating actions taken on investment-grade U.S. corporates as a result, at least in part, of increased share repurchase activity. This compares with only three similar actions in 2010. In addition, there have been at least six accelerated repurchase programs that caused leverage for Fitch-rated issuers to increase without resulting in a negative rating action.
The pace of shareholder-friendly actions by investment-grade corporates began to pick up significantly in early 2011, and accelerated last September as a sell off in global equities and persistently low borrowing costs sparked more share repurchases. Yields on 10-year 'A' corporate bonds fell from the mid-4% range in first-quarter 2011 to 3.3% at the end of the year, while the decline in the S&P 500 after July pushed stock valuations down to attractive levels.
A similar pattern may be taking shape in second-quarter 2012 as share prices have declined sharply from early 2012 peaks in response to growing concerns over euro zone contagion risk and the global slowdown. Lacking compelling growth capex and acquisition opportunities, many investment-grade corporates may again be forced to evaluate shareholder-friendly (and typically bondholder-unfriendly) actions in the second half of the year to boost equity returns in a slow-growth environment.
More aggressive approaches to cash deployment have not been confined to a narrow range of sectors. Repurchase programs, often leading to downgrades, have been accelerated in the retail, pharmaceutical, consumer, technology, and media sectors over the past year. In some cases, investment-grade borrowers have been willing to test the boundaries of investment-grade ratings, as seen in the case of Safeway, which was downgraded to 'BBB-' last November.
We believe the surge in share repurchase activity has reflected not only favorable market conditions, but also a willingness on the part of some management teams to move down the credit spectrum, trading off a degree of financial flexibility for equity returns. In a benign credit environment investment-grade corporates have not paid a stiff price for this trade off. Still, it leaves companies with reduced flexibility to respond to future economic shocks and tightening credit market conditions.
For a review of U.S. corporate share repurchase activity and the importance of buybacks as a cause of recent downgrades, see "Buybacks Up, Ratings Down," dated April 19, 2012, at www.fitchratings.com.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
Applicable Criteria and Related Research:
Buybacks Up, Ratings Down: Share Repurchases Lead to Multiple Downgrades
Brian Bertsch, +1-212-908-0549
Media Relations, New York
Philip M. Zahn, CFA, +1-312-368-2336
70 W. Madison
Chicago, IL 60602
Bill Warlick, +1-312-368-3141