LONDON (Reuters) - Ramped-up monetary stimulus from the European Central Bank is likely to fuel investor unease over companies funneling cash into share buybacks - which have hit a four-year high - rather than investment, asset managers warned.
While the euro zone is so far only in the early stages of quantitative easing compared with the United States, corporate cash spending trends already favor bigger shareholder payouts and stock buybacks as rock-bottom yields and a cloudy outlook for final demand deter long-term investment.
European share buybacks have year-to-date hit their highest level since 2011 in U.S. dollar terms, at around $55.4 billion, up 7 percent from the same period last year and almost double that in the comparable 2012 period, according to Thomson Reuters data.
With ECB chief Mario Draghi offering the strongest hint yet that even cheaper money is on the way, European companies are under pressure to find safe havens or quick-fix balance-sheet solutions for their $1 trillion-plus total cash piles -- and shareholders may start to push back.
“Companies are still not rewarded for investment, for capex, but for share buybacks. That has to change,” said Rod Paris, Chief Investment Officer at Standard Life Investments, at the Reuters Global Investment Outlook Summit.
“The signal investors send has to change.”
This may seem paradoxical: after all, some of the biggest cheerleaders of capital return are shareholders themselves, with some activists buying stakes in companies to push for more.
And while Europe has attracted less shareholder activism than the United States, markets have cheered buybacks and punished capex.
Recent examples include Vestas Wind Systems, whose shares hit a six-year high after it announced a buyback program following better-than-expected results, while German lighting maker Osram plunged as much as 24 percent after announcing a new investment plan and factory in Malaysia that analysts deemed both costly and risky.
But the QE-driven market rally has also run into volatility this year, as years of easy money call into question the credibility and effectiveness of central banks. Some say the focus will shift to companies’ ability to boost revenue growth and the strength of economic recovery at large.
“We would much rather equity market performance was driven by economic activity and by growing top lines than by some sort of financial sleight of hand,” Ken Lambden, CIO at Barings Asset Management, told the summit.
“That’s the concern that we have ... There has been a lot of buyback activity.”
However, the alternative choice, to reinvest capital, generates the highest returns with greater risk of failure, according to research from Credit Suisse’s corporate advisory team on U.S. spending. Done right, capex led to average outperformance of 14 percent; done wrong, it led to average underperformance of 14 percent.
Blaming a lack of economic growth for the boom in capital return to shareholders is therefore not entirely convincing, according to Rick Faery, head of Credit Suisse’s HOLT corporate advisory team. He said even a rise in U.S. interest rates, while certainly making it more expensive for companies to borrow funds to buy back shares, might not shake things up.
So pressure to shift spending toward investment may have to come from the market after all.
“The signal the corporate sector (currently) gets from higher equity prices is: ‘We are not going to invest in a new greenfield power plant ... (but) we might do some financial engineering of the balance sheet,’” said Percival Stanion, head of multi asset at Pictet Asset Management.
Reporting by Lionel Laurent; Editing by Ruth Pitchford
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