Shareholder Distributions: This Is The Peak

Factset just released its FactSet Cash & Investment Quarterly which is very instructive on the fundamental trends in corporate America and the increasing risk investors are taking buying equities on the basis of increasing shareholder distributions..

• The S&P 500 (Ex-Financials) cash and short-term investments balance (“cash”) amounted to $1.456 trillion at the end of the second quarter, which marked a 1.1% increase from the year-ago quarter, but a 0.2% decline from Q1.

The S&P 500 cash balance has been flat for 7 quarters now. IT companies are the big cash generators (see CETERIS NON PARIBUS), accounting for 43% of the total, up from 38% one year ago, as their cash balance grew 15% YoY. Non-IT companies are not doing as well as their cash balances declined 6.9% YoY.

Meanwhile,

• Total debt for the index increased 7.6% year-over-year, reaching its largest level in at last ten years. Looking at the YOY average growth rate going back three years, growth in debt has increased at pace 1.7 times faster than the growth in cash and short-term investments. This was while cash was rising pretty fast.
• As a result, the S&P 500 (Ex-Financials) cash to debt ratio decreased 6% YoY to 33%. This represented a 1% drop from Q1 and also marked the lowest ratio since Q2 2009.
• All 10 sectors but one (Industrials) now have a cash to debt ratio below their 10Yr average. Even with its strong cash generation, the Information Technology sector had it lowest cash to debt ratio in at least ten years at the end of the quarter (116.7%).

Let’s look at profitability and indebtedness:

• Aggregate EBITDA over the trailing twelve months ending in Q2 amounted to its lowest total since Q3 2013.
• At the end of the second quarter, the net debt to EBITDA ratio for the S&P 500 (Ex-Financials) was 1.83%, which marked the highest ratio in at least ten years. Net debt to EBITDA is now much higher than at the trough of the financial crisis in 2008-09.
• The trend is worsening at an accelerating rate: the second quarter was the fifth consecutive quarter that the ratio hit a new high. The ratio represented a 13.7% increase from the year-ago quarter and a 2.8% jump from Q1.

Rising debt, declining cash flows and reduced debt coverage inevitably lead to a revaluation of corporate strategies:

• On a TTM basis ending in Q2, CapEx for the S&P 500 (Ex Financials) amounted to $608.3 billion, which represented an 8.7% decline from the same time period a year ago. The TTM amount marked the smallest total since Q3 2012. Additionally, the trailing twelve-month CapEx to sales ratio was 6.7%, which represented a 6.5% decline from the same time period a year ago. This marked the lowest ratio for the index since Q3 2012.
• The Energy sector saw the largest YoY decline in quarterly CapEx during the second quarter. Quarterly capital expenditures amounted to $23.2 billion, which represented a 40.4% decrease from the year-ago quarter. The quarter marked the sixth consecutive quarter that Energy CapEx saw a YoY decline. In the trailing twelve months ending in Q2, aggregate capital expenditures in the Energy sector marked the smallest TTM amount since the period ending in Q2 2010.
• Ex-Energy, capex grew 2.8% YoY in Q2’16 but the TTM trend is now negative.

• Companies in the S&P 500 (Ex-Financials) index generated $332.7 billion in operating cash flow (OCF) during Q2, which was a 2.7% decline from the year-ago quarter, but just about in line with the five-year average. Over the trailing twelve months ending in Q2, operating cash flow declined 2.7% to its lowest total since Q4 2013.

• After subtracting fixed capital expenditures from operating cash flow, aggregate free cash flow amounted to $187.9 billion, which reflected a 1.7% increase from the year-ago quarter. This was driven by capital expenditures for the index falling at a faster clip than operating cash flow during the second quarter.
• Quarterly net shareholder distributions, which are calculated by adding dividend payments and net purchases of stock, amounted to $176.6 billion in Q2. This represented a 1.7% decrease YoY and a 13.2% drop from a quarter ago. The sequential decline was primarily driven by the sharp decrease in quarterly share buybacks during Q2. The second quarter was the smallest amount of net shareholder distributions for the S&P 500 (Ex-Financials) since Q1 2015.

Considering the S&P 500 Index (ex-Financials) as one company, this is what we are currently seeing:

• Profits have dropped for 7 consecutive quarters as sales have slowed to a crawl and margins have declined.
• Cash flows are also weakening.
• Net debt to EBITDA has exploded in the last 2 years and now substantially exceeds the previous peak of 2008-09.
• Given this deterioration in the company’s financial conditions, capex budgets are being trimmed.
• Furthermore, the company is compelled to curtail its shareholder distributions, impacting both share buybacks and dividend payments.

Since 2014, RBC Capital calculates that S&P 500 companies have grown their aggregate sales 0.8% in total but operating earnings per share have advanced 6.8% over the period. Share buybacks contributed 6.3% to EPS growth, or 93% of the total. This contribution looks set to disappear in coming quarters:

• Companies in the S&P 500 spent $125.1 billion on share buybacks during the second quarter, which marked the smallest quarterly total since Q3 2013. Aggregate buybacks in Q2 represented a 6.8% decline from the year-ago quarter, which was the largest YoY decrease since Q1 2015.
• The number of S&P 500 companies participating in buybacks fell sharply in Q2. During the quarter, 350 companies engaged in share buybacks, which was a significant decrease from the 380 participants in Q2 2015. The second quarter marked the lowest buyback participation rate since Q4 2010, when only 337 firms in the index performed share buybacks.
• At the end of the second quarter, 137 companies in the S&P 500 spent more on buybacks in the trailing twelve months than they generated in earnings. This marked the eighth highest count since the beginning of 2005.

Unlike buybacks which are highly discretionary to management post board approvals, dividend rates are meant to be very stable which is why directors are more careful and need convincing that profits will remain solid before approving dividend hikes. The recent slowdown in dividend growth rates is symptomatic of the very subdued business outlook.

• Aggregate quarterly dividends for the S&P 500 amounted to $105.8 billion in the second quarter, which represented a 0.8% increase YoY, a marked slowdown from the 7.1% increase recorded during the trailing 12-months period.
• On a per share basis, the YoY growth rate in the second quarter was 6.1%, which was well-below the three-year average growth rate for the index (10.8%).
• The number of companies raising their dividends peaked at 340 in the spring of 2015 and declined to 294 during the last 3 months. Meanwhile, 18 companies cut their dividends during the last 3 months. That number usually fluctuates around 5 most of the time. It reached 35 after the 2001 recession and an extraordinary 65 during 2009.

In any case, dividend growth looks set to slow appreciably, potentially grinding to a halt as payouts have reached historically high levels:

Finally, add the impact extraordinarily low interest rates are having on corporate pension funds. CFOs are urging CEOs to take it easy because unfunded liabilities are growing fast and will eventually need to get funded. Go back to the first chart and consider the more than $400 billion in unfunded liabilities in the debt/ EBITDA ratio…BTW, most companies approve new annual pension funding amounts during the 4th quarter. No analysts account for these adjustments in their forecasts.

(Credit Suisse via The Daily Shot)

To give you an idea of the potential earnings impact, Mercer estimates that the cost of contributions to defined benefit pension schemes will rise by over £2bn to £10.9bn in 2017 in the UK. This is a 22% jump in pension costs for 2017. That amounts to 13% of the £84bn pre-tax profit FTSE 350 companies earned in 2015 according to Mercer.

FYI, during the last 12 months, the ProShares S&P 500 Dividend Aristocrats ETF has appreciated 13.6%, handily beating the S&P 500 ‘s 9.3% gain.

• How Much Are Those Dividends Costing You?