OCEAN CITY — The U.S. economy may have hit a soft patch, but there’s been no letup in the confidence of corporate CEOs to spend their cash. U.S. companies have been shelling out record sums to raise their dividends, buy back shares and, more recently, do deals.
Companies are flush with cash accrued over the last six years. The economy has been slowly recovering, labor costs remain low, and technological innovation has caused profit margins to climb to historic levels. With rising sales and profits, cash on corporate balance sheets has grown to roughly $1.4 trillion for S&P 500 non-financial companies.
We think the continued deployment of this cash for shareholder-friendly activities is a positive for the market.
A company’s capital allocation decisions generally depend on views of the economy, the health of the business and efforts to maximize value for shareholders. With an improving economy, CEO confidence has risen and so has the use of dividends and share buybacks.
For income-seeking investors, a company that pays a stable dividend is attractive while a steadily growing dividend can help mark it as a high-quality business. Share buybacks provide one-time rewards to shareholders, afford managers flexibility and signal to the market that they believe their stock is priced attractively.
Lately companies have upped the ante on using their cash for deal-making, including mergers, acquisitions and divestitures. Earlier this month Royal Dutch Shell announced it would buy BG Group for $70 billion, while merger mania in the pharmaceutical space has led to Teva bidding $40 billion for rival Mylan, which in turn is courting Perrigo with a $32 billion offer.
Merger and acquisition (M&A) activity has been steadily increasing in the years following the global financial crisis, with 11,000 deals worth a combined $1.2 trillion completed last year in the U.S., according to Bloomberg. So far this year, deals for S&P 500 companies totaled 191 on an annualized basis, which compares to 232 and 350, respectively, for the peaks in 2000 and 2007, according to the BofA Merrill Lynch (BofAML) Global Research U.S. Equity Strategy team. In cross-border deals, last year’s volume surpassed the $1 trillion mark for only the second time since 2000.
We expect deal activity to remain robust as the factors that have driven it in recent years persist. Global liquidity remains high and companies can borrow at lower financing rates. A weak earnings picture given currency headwinds and lower commodity prices may encourage companies to make acquisitions to “buy growth.”
M&A remains a natural way to appease investors, fulfill growth mandates and deploy cash in a productive manner. However, in the overall capital allocation decision, deal-making tends to be the most risky due to the challenges of retaining key employees and integrating operations.
(A Merrill Lynch Wealth Management Advisor who can be reached at 410-213-8520.)