Canadian companies reluctant to reinvest excess cash are instead buying back their own shares at a furious pace.
Buybacks by companies in the S&P/TSX Composite Index soared to nearly $50-billion in the 12 months up to the end of the first quarter. As a proportion of the whole stock market, that’s around 50 per cent higher than the previous record set a decade ago, according to a report by Ian de Verteuil, head of portfolio strategy for CIBC World Markets.
“It has taken some time, but C-suite executives in Canada appear to have found religion on buybacks,” he said.
It is a devotion with a downside, however. While buybacks are a quick way to deploy extra cash, reward shareholders, and support an undervalued stock, the corporate sectors in Canada and the United States have a poor record of timing buybacks, historically resorting to them most aggressively at market peaks.
“Buybacks are a bull market phenomenon,” said Jason Mann, chief investment officer of Toronto-based Edgehill Partners. “Confidence is high, excess profits are high, but so are valuations.”
But not all stocks are at or near record highs. For many Canadian companies, and even entire sectors, buybacks make good sense right now.
Canada’s lack of pipeline capacity, combined with continuing energy production curtailment, has frozen expansion plans in the oil patch.
But most companies still generate more than enough cash to maintain operations and continue paying existing dividends, at least when crude oil is priced higher than about US$50 a barrel. West Texas Intermediate currently sits at about US$52 a barrel, but was as high as US$66 in April.
“Now is the time to halt production growth, or moderate it at least, and prioritize the return of capital,” said Eric Nuttall, senior portfolio manager at Ninepoint Partners.
The case for buybacks is strengthened by energy stock valuations, which have fallen in aggregate by more than half over the course of the last four to five years. Over that time, booming U.S. shale production drove a global oversupply, which was made worse in Canada by challenges in transporting product to market.
Many Canadian producers have responded to the call for mass buybacks. Whitecap Resources Inc., for example, expects its total buybacks will rise to up to 25 million shares over the next year.
The big names of the oil patch have also seen the logic of buybacks, with Suncor Energy Inc. and Encana Corp. among the 15 Canadian companies committing the most money to repurchases over the last two decades, according to the CIBC report.
The Canadian buyback bonanza extends well beyond the energy sector, however. The big banks, as well as the railways, have contributed to the surge.
Both of those sectors, like energy, have some things in common right now – “modest growth potential and relatively solid profitability,” Mr. de Verteuil said.
The global financial crisis and its aftermath generally shelved repurchase programs in Canadian banking, as building up capital became the priority.
With the sector as a whole now sporting a “very comfortable” capital buffer, bank buybacks should remain a powerful force in Canada, and throughout the domestic stock market as a whole, Mr. de Verteuil said.
The global trade war has added a new layer of risk to corporate expansion. With competing tariffs between the United States and China taking a toll on global growth, and the North American trading relationship on tenuous ground, Canadian management teams are putting expansion plans on hold, Mr. Mann said.
That’s not to say that buybacks are always the best use of alternative capital. General Electric Co. should serve as a cautionary example, said John Zechner, president of wealth management company J. Zechner Associates. In 2016 and 2017, GE bought back US$24-billion worth of stock at prices in excess of US$20 a share.
“Those purchases look like a very poor investment with the stock now trading in the US$10 range and the company suffering from an over-indebted balance sheet,” Mr. Zechner said.
In both Canada and the United States, historically high levels of corporate debt will soon force many companies to rethink their buyback plans, Mr. Zechner said.
“Debt-heavy businesses will need to shore up their balance sheets by diverting cash flows toward debt-service repayment and debt retirement. That could slow the flow of money to stock buybacks.”