Investors target ‘buyback stocks’ in bet on tax plan
NEW YORK (Reuters) – Rather than waiting to see how the Republican tax bill will fare in Congress, some investors already are picking out technology, health-care and consumer companies they expect will use potential tax savings to buy back more of their own stock.
Fund managers including Columbia Threadneedle Investments, Hodges Capital and SSI Investment Management are among those that are adding to or holding on to their shares of companies such as Texas Instruments Inc., Microsoft Co. and Southwest Airlines Co. in part because they expect to see more share buybacks or special dividends if tax reform passes in some form.
The House Republican plan would cut corporate taxes to 20% from 35% and allow companies to bring back foreign profits at a 12% tax rate, a process known as repatriation. Overall, US companies hold some $2.6 trillion in untaxed offshore cash.
Fund managers say that while it is far too soon to tell whether the tax bill will pass, the prospect of increased buybacks is worth taking a bet on companies that would benefit the most from the plan.
“If you have two companies that you are looking at, and one would get a bigger boost from bringing back its cash from overseas, that provides an extra level of return,” said Peter Santoro, a portfolio manager of the $11 billion Columbia Dividend Income fund.
For example, he said, cash-rich tech companies with a big international presence, such as Microsoft, are likely to return cash to shareholders via a one-time dividend even if Congress passes a repatriation bill rather than broad tax reform.
When Congress allowed US companies to bring back foreign profits at a discounted tax rate in 2004, Microsoft issued a special $3-per-share dividend, and the Trump tax windfall would likely lead to something similar, Santoro said.
He declined to say whether he was adding to his Microsoft position in recent months. Microsoft is the largest position in Santoro’s fund, according to Morningstar data, and its shares are up 36% for the year, largely driven by the expansion of its cloud-based business.
Goldman Sachs estimates that the Republican tax bill would increase corporate buybacks by $75b., to $590b., in 2018. Bank of America Merrill Lynch estimates about half of repatriated cash would go into buybacks, while the rest would get spent on acquisitions and other investments.
Stock buybacks often provide a shortterm bump in a company’s share price both by eliminating the total number of available shares and improving metrics such as earnings per share and return on equity.
LAGGING THE MARKET
Yet buybacks, which peaked in 2016, have been slowing over the last three years, as rising stock valuations made them more costly, and investors called on companies to invest more in their future by spending on factories or research.
The S&P 500 Buyback Index is lagging the broader market this year after having beaten the S&P 500 by nearly 83% between 2009 and the end of 2016. The buyback index tracks 100 of the companies in the S&P 500 with the highest buyback ratios, such as Boeing Co., Michael Kors Holdings and Tyson Foods Inc.
The Powershares Buyback Achievers fund, which tracks companies that have repurchased at least 5% of their outstanding shares over the last 12 months, is up 11.2% so far this year, compared with a 15.7% gain in S&P 500.
Eric Marshall, a fund manager at Hodges Capital, which manages $2b., said he has been adding to his position in buyback-heavy companies such as Texas Instruments and Lowe’s Companies Inc. because he expects them to increase their current buyback programs if a tax bill does pass.
Texas Instruments, for instance, said in September it would buy a further $6b. of its own shares, extending a program that has reduced its total number of shares by a quarter over the last five years. Texas Instruments shares make up about 2% of the Hodges Blue Chip Equity Income fund. The firm last bought the stock in June, according to the latest publicly available data.
‘If you have two companies that you are looking at, and one would get a bigger boost from bringing back its cash from overseas, that provides an extra level of return’
“Buybacks are the most tax-efficient thing you can do with your capital, and when you repurchase your own stock, you know exactly what you are buying,” Marshall said.
Ravi Malik, a portfolio manager at SSI Investment Management Inc., which manages $1.6b., said a cut in the repatriation rate would benefit convertible bonds in his portfolio, such as Citrix Systems Inc., Amgen Inc. and Lam Research Corp.
SSI Investment examines its biggest holdings with a significant share of overseas revenues to assess the impact of tax legislation on those companies, he said, adding: “That’s how we identified these companies as significant beneficiaries of the changes proposed.”
Barry James, a portfolio manager of the $3.1b. James Balanced Golden Rainbow fund, said he expected fund holdings, such as lawnmower maker Toro Co. and Southwest Airlines to boost existing buyback schemes should a tax bill pass. Such a move would be preferable to an acquisition or hiring more employees, he said.
“Over the long run, we are fans of companies that reward shareholders, and now is not the right time to find an acquisition cheaply,” James said.