Edge and Odds

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Edge and Odds

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Month: June 2014

EUROZONE MANUFACTURING PMI SLIPS TO 52.2

The recovery in the eurozone manufacturing sector registered a modest slowdown in May. At 52.2, down from 53.4 in April, the final seasonally adjusted Markit Eurozone Manufacturing PMI® posted its lowest reading in six months and came in below the earlier flash estimate (52.5), but remained at a level consistent with a solid improvement in operating conditions.

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The easing signalled by the headline PMI reflected slower rates of expansion in production, new orders and employment. Companies also reported a sharper cut in inventories of purchased goods. Almost all of the nations covered saw their PMI remain above the 50.0 no-change mark, but only the Netherlands and Spain reported faster rates of growth. France, in contrast, fell back into contraction after expanding in the prior two months.

Eurozone manufacturing output and new orders both expanded for the eleventh successive month in May, imagedespite growth easing to the lowest since last November in both cases. Only the Netherlands reported a faster expansion of output, while none of the nations for which May data were available saw improved new order growth. The slower rate of increase in new business meant that backlogs of work fell for the first time since last September.

France was the weakest performer overall, being the only nation to report a decline in new business and a near-stagnant rate of increase in production. France was hit by weaker inflows of both domestic and new export orders, despite firms’ attempts to shore up demand through discounted prices.

Lower selling prices were also reported in Austria and Greece. However, these were offset by higher output charges in Germany, Italy, Spain and the Netherlands, meaning that eurozone manufacturing selling prices increased (on average) for the first time in three months.

The rate of decline in input prices also eased during the latest survey period. Although costs fell for the fourth straight month, the decrease was the least marked since February. Italy, Spain and Greece all reported higher input prices, while rates of decrease slowed in Germany, France, the Netherlands and Austria.

The level of new export orders at eurozone manufacturers increased for the eleventh successive month, with gains reported by all nations bar France. Companies reported stronger demand from the US, Asia and other European markets. However, the rate of increase in new export business was the lowest since last July.

Employment rose for the fifth successive month in May. Job creation was signalled by manufacturers in Germany, Italy, Spain, the Netherlands, Austria and Greece, although the Netherlands was the only nation to signal a stronger pace of increase. France reported further job cuts.

SHARE BUYBACKS IMPACT ON EARNINGS GROWTH, QUALITY

Pat S., an old Irish friend, writes:

Denis,
Looking at Dr Ed Yardeni’s website on historic earnings, I noticed that economic depreciation on replacement cost of fixed assets has turned sharply lower than depreciation reported by corporations for taxes in recent years. This isn’t due to 1970s style inflation, so it must be due to under investment. The seed corn is being eaten by share buybacks! That means a reduced quality of s&p eps.

There is a lot of stuff in this note but, being no economist, I will cut to the chase:

  • The accounting for capex and depreciation in the national accounts does not hit a strong side of mine. I suspect, however, that trends towards outsourcing and the use of foreign subsidiaries for tax purposes blur long term relationships between capital investments, depreciation accounting and tax accounting.
  • Gross capex in the U.S. grew very rapidly between 1992 and 2005, seemingly too quickly (and financially poorly) judging from low capacity utilization rates from 1998 to 2012.

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  • Corporations are back to a capex trend more similar to that of the early 1980s. Utilization rates may be back to 2005 levels, they nevertheless remain at the low end of their long-term range. CFOs are thus little inclined to boost capex even now, five years into the recovery and with interest rates at such low levels.
  • The “under-investment” thesis does not strike me as solid.
  • Meanwhile, cash is mounting and many corporations buy back their shares rather than boost unnecessary capex.
  • Share buybacks may or may not be a financially smart move. We must be careful when analysing aggregate buyback data. There is a lot of excess cash but, upon closer examination, most of it rests in but a few companies. So with buybacks these days.
  • In effect, Apple and IBM accounted for 9% of buybacks in Q4’13. The 5 largest buybacks represented 18.3% of all buybacks in Q4, the 10 largest: 27.3%. The ratios are very similar for all of 2013.
  • Apple was the most active re-purchaser in 2013, buying back 5% of its outstanding shares. I challenge people to dispute the wisdom of Apple’s repurchase considering that its stock traded between 9 and 14x trailing EPS (cum a huge excess cash position) and between 3 and 4 times BV when its ROE is 30%+. Pfizer, the second most active re-purchaser in 2013, bought back 11.2% of its shares at about 2.5x BV when its ROE is 19%. When cash yields less than 1%, buybacks are hard to pass with such metrics.
  • In fact, the math says that these 2 companies should witness an acceleration in their growth rate post these buybacks. Cash earning 1% dilutes growth and if you can reinvest it in an asset earning 8-10%, growth is enhanced.
  • Share repurchases are only one factor determining the change in share count of a company. Most buybacks also seek to offset dilution from convertible securities or stock options, or the issuance of stock for acquisitions.
  • Data from S&P shows that buybacks, in aggregate, have only reduced total shares outstanding by 1.2% over the last 4 years. Shares o/s declined 0.5% Y/Y in Q3’13, 0.12% in Q4’13 and rose 0.12% in Q1’14 (Charts below from Factset).

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  • There is no evidence that U.S. corporations are sacrificing capex for buybacks.

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