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Why Stocks Are Sliding: For The First Time Since 2009 Spending On Buybacks Surpasses Free Cash Flow
Back in early 2014, we first explained how it was possible that with the Fed's QE tapering, the S&P kept rising higher despite declining intervention by the Fed in capital markets: the answer was corporate buybacks, which had then soared to the highest level in history.
This artificial stock-support by CFOs and Treasurers only increased in the subsequent year, with buyback announcements hitting a record high one year later, in May 2015, as also profiled previously.
Then after the early euphoria of 2015, repurchase activity slowed down. As Factset observes in its just released quarterly buyback report, the dollar-value of share repurchases amounted to $134.4 billion over the second quarter (July), which represented a 6.9% decline from the first quarter (April) and a 0.4% decline year-over-year. On a trailing twelve-month basis (TTM), dollar-value share repurchases totaled $555.5 billion, which was approximately flat with the first quarter.
On the surface, this is good news, but, and here there is a huge "but"... because the reason for the drop off in buybacks has nothing to do with corporate executives reigning in their desires for higher stock prices and thus, higher equity-linked compensation, and everything to do with funding limits. Because while buyback activity may be slowing down it is only due to one thing: a collapse in free cash flow among S&P500 companies, with energy companies at the forefront, but increasingly all sectors being hit by a dramatic slow down in FCF creation. According to Factset while LTM buybacks declined by 1.3%, Free Cash Flow over the same period plunged by a whopping 29%!
In fact, as Factset notes, in the past 12 months, for the first time since October 2009 the amount spent by companies on buybacks has surpassed the Free Cash Flow of the S&P 500 itself! In other words, the only use of funds for the 500 or so companies in the biggest stock index in the world is to... push their stock even higher. It also means that any incremental "use of funds" such as M&A, dividends, capex or just plain organic growth, would have to be funded through issuance of debt.
From FactSet:
Although the aggregate dollar-value of share buybacks declined sequentially in the second quarter on a TTM basis, companies in the S&P 500 still spent more on buybacks than they generated in free cash flow. Free cash flow is defined as cash from operating activities minus capital expenditures from fixed assets and cash dividends paid. The aggregate Buybacks to Free Cash Flow ratio for the S&P 500 exceeded 100% for the first time since October 2009. The ratio hit 108% on a TTM basis at the end of Q2, which represented a 12.9% increase quarter-over-quarter and a 42% increase year-over-year. The 10-year median ratio was 72.2%. At the sector level, four out of the ten GICS sectors had a ratio greater than 100% at the end of Q2 (Consumer Discretionary, Consumer Staples, Industrials, and Materials).
What is driving this ratio to such high levels? As mentioned earlier in this report, the TTM dollar-value share repurchases in Q2 amounted to $555.5 billion, which was a 1.3% increase year-over-year. This partly contributed to the higher ratio, but the main driver was free cash flow. TTM free cash flow at the end of Q2 totaled $514.4 billion, which represented a 28.6% decline year-over-year. The aggregate FCF for Q2 was the lowest level for the S&P 500 since Q3 2009, when FCF amounted to $140.2 billion.
The sectors leading the decline in free cash flow were Energy and Financials. Financials saw a 50.2% decline in FCF year-over-year, with State Street Corporation heavily contributing to this decline. State Street reported cash flow from operations of -$5.1 billion in the TTM ending Q2 2015 after reporting a $907 million inflow in the TTM from the year ago quarter. The Energy sector, which typically has high levels of fixed capital expenditures, saw free cash outflows totaling -$65 billion in the TTM ending Q2. Free cash outflows amounted to -$7.1 billion in the TTM ending Q2 2014. Southwestern Energy was another large contributor, as it increased its fixed capital expenditures by almost 250%, leaving it with free cash outflows of -$5.7 billion in in the TTM ending Q2. The company reported free cash inflows of $4 billion in the TTM from the year ago quarter. Due to decreases in free cash flow, buyback spending for the S&P 500 is now 1.08 times TTM free cash flow, which has surpassed the 10-year average of 1.05 times free cash flow.
And voila:
And that, in a nutshell, is why the market is tumbling today: it is not so much longstanding fears of a Chinese collapse (although these are certainly relevant), nor the threat of a European recession due to the Volkswagen scandal (which is certainly an issue but will be resolved promptly once enough congressional palms are greased) nor the long-telegraphed plunge in Glencore and other miners (this too will get much worse before it gets better) - no, the catalyst for today's dump is that the biggest buyers of stock in the past 2 years, the corporations themselves, just priced themselves out of the market and no longer generate the cash needed to push their own stock to new all time high levels in a thin, illiquid market in which the orders from Goldman's buyback desk are the marginal price setter.
It is very possible that the current quarter may well be the last push to keep stocks levitated, and until and unless there is a substantial increase in free cash flow (unclear what would cause this), companies will slam shut the buyback spigot, especially when the vast majority of CFOs realize that the returns on the latest year of buybacks just turned negative and the board says "no more."
As for what happens when companies decide to proceed with buybacks anyway and issue billions in debt just to fund these and keep the party going a little longer (even if if means risking their Investment Grade rating in the process) look no further than IBM and HP for the outcome.
Source: FactSet
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But companies can borrow at almost zero cost. Perhaps, we need NIRP.
When we pay companies to borrow, the market rally will resume.
This is the financial version of the snake eating its tail.
The Ouroboros
https://ouroborostudio.files.wordpress.com/2009/09/ouroboros_02.jpg
If Munchausen can do it, surely our illustrious corporations can as well.
http://www.vokrugsveta.ru/encyclopedia/images/a/a8/Baron_01.jpeg
Damm..
I just typed this out before reading any of the thread..
The snake has its tail in its mouth and is trying to swallow it whole.
Heh heh..
Great minds and all that. :- )
This Is Who We Are - Millennium
http://millennium-thisiswhoweare.net/images/welcome_laura.jpg
Long live Frank Black !
Cleary corporate America is bullish on growth prospects, right guys?
Tsk, they'e running out of other peoples money and the way the economy is going they leveraged themselves into a deep hole......
This is the financial version of the snake eating its tail.
Hey, wait a minute . . .
LOL ! Sorry.....I invoke the Fair Use Rule. ; )
Waiting for the first "purple nirple" article...
ADP is getting in debt to buy its stock back.
Generally agree with the article. But my understanding is that most companies borrowed for share buybacks simply due to the exceedingly low borrowing costs. That they did not use free cash flow for this purpose. Am I wrong?
http://www.bloomberg.com/news/articles/2014-10-06/s-p-500-companies-spend-almost-all-profits-on-buybacks-payouts
Going on a couple years...
It's all related. ZIRP (NIRP), QE, etc. Cheap borrowing, restructuring of debts, and so on. Nothing for Cap Ex. Nothing actually based on real growth. All getting pumped into buybacks.
And dividends.
Yup. A corporate free-for-all. "Game over" is being signaled.
NIRP and confiscation of retail bank accounts to fill this gap.
Autozone bitches...
It is a complete fucking joke that these public companies are buying their stock back when the shares are at all time highs. All this does is jack up their bonuses which are tied to the stock prices, while hiding how shittily their actual business is doing.
Better than paying dindu nuffins to dindu nuffin
Quick! QE! Stat! Code blue, code blue.
Thinking that this is also not the best environment for selling more public shares to increase cash. They can't pile up the shares, then buy them back later at a higher price.
Reverse splits to the moon!
Until someone realizes that the same mindset is required to buy both your own STOCK and your own PRODUCT!. If you are willing to spend hundreds of billions to prop up your market cap... what prevents you from spending a few billions to ensure a succefull "launch" for you new phone?
Sometime ago, Samsung admitted to have 30 million unsold units of their Galaxy 5, to great pain to his stock price. Apple also sensed this trend and tried to cut production of his model 5, but discovered, in horror, that analysts had an eye in their supply chain so this was promptly detected. As a result, there's probably a new patch of land mid-way from China...
Ah....your post reminds me of my younger dark age.
https://en.wikipedia.org/wiki/Atari_video_game_burial
I was thinking EXACTLY about that! my young Padawan :)
Buyback TFD. heh.
3:30 ramp time.
It's like your maid is blowing through your bank account and leveraging up to buy off your wife to allow her to keep working for you.
That's how criminal this is. The CEO is the manager of the company. Not the owner. And these corporate boards are criminals too.
Yet another reason not to own equities. You own NOTHING. You control NOTHING. They openly spit in your face.
All tied to Goldman Sachs; the name is arrogant in and of itself. Now the Jesuit Poop is coming to visit the Jesuit hive in NYC, where the NY Fed is the Jesuit entity of the Americas. Death to the anti-Christ pope who says nothing about these drone murders and wars and will come and blame "capitalism", which he obviously cannot recognize, for we do not have capitalism unless you consider lying, stealing, cheating and murder as capitalism. The Pope is not the leader of the church of Jesus Christ; yet to be revealed, but rather the Church of Satan that is visible everywhere.
By any chance is your other ZH username joo_spindoctor?
at 3:45ish...PPT IS IN DA HOUZE.
Almost all F500 companies are owned by the criminal syndicate.
Nationalizing these companies will not limit their power.
They run the government too.
LOL
You are so fucked, it's beyond the imagination.
PP team is going to sue, they THEY are the ones inflating stock prices, that is all.
They should have 100 pound fishing line tied to their "fill in the blank" and dropped off at 90 yards with 60 yards of line and a net at the bottom to prevent them from dying on the spot.
I AM SICK AND DAMN TIRED OF THE HFT INTERVENTION ON A DAILY BASIS!! Just look daily at the last 30 minutes of trading and throughout the day; this market wants to crash. BASTARDS will be burning in hell unless.....
I guarantee you that the FED, the PPT, and it's posse burned a whole lot of taxpayer money trying the right this ship after 3pm.
Too bad (for us) that it'll not make any difference anyway. Hey, just put it on the balance sheet with all the worthless MBS securities bought from the TBTFs, etc and all the other shit.
I am starting to get a sick kind of enjoyment outta watching them desperately pull back on the stick to get more altitude, but it goes up less and less each time.
Nice! Let them bleeds small money that they have. Then next? Another QE!! Yay!!
(/sarcasm)
Here are some more signs of a coming recession.
http://michaelekelley.com/2015/05/29/mergers-and-acquisitions-set-record...
http://michaelekelley.com/2015/02/20/fed-warns-of-two-bubbles/
http://michaelekelley.com/2015/02/24/would-you-pay-39-more-than-asked/
http://www.zerohedge.com/news/2015-07-27/when-will-we-ever-learn/
Here is how to respond.
http://michaelekelley.com/2014/10/16/8-things-to-do-when-recession-happens/
Here is how to get your mind off this stuff.
http://michaelekelley.com/category/humor/
Good luck!
We have Peak Buyback trough Peak Credit so the FED can't hike rates and moreover will open the QE floodgates to prevent the market from collapsing. Draghi said it: 'Whatever it Takes!'