S&P 500 companies will spend about $780 billion on share buybacks in 2017, marking a 30% rise from 2016, buoyed by corporate tax reform and the repatriation of cash from overseas, buybacks will account for the greatest share of cash use by S&P 500 companies for just the second time in 20 years, analysts wrote in a note. They are expecting companies to spend a total of $2.6 trillion next year, with 52% going to investing for growth, in the form of capital spending, research & development and mergers and acquisitions. The remaining 48% will go to shareholder awards, in the form of share buybacks and dividends.
“We expect tax reform legislation under the Trump administration will encourage firms to repatriate $200 billion of overseas cash next year,” analysts wrote. “A significant portion of returning funds will be directed to buybacks based on the pattern of the tax holiday in 2004.”
Share buybacks have become a popular way for companies to return capital to shareholders. The idea is that buybacks boost earnings per share by reducing the number of shares outstanding, and the additional buying can raise the share price.
Goldman is expecting companies to increase the amount spent investing for growth by 6% to $1.3 trillion, but will increase cash returned to shareholders by 19% to $1.2 trillion. Spending by companies outside of the energy space is expected to grow by 7%, while spending by energy companies should recover somewhat assuming oil prices continue to stabilize.
“Modest U.S. GDP growth of around 2% and ex-Energy earnings growth of 6% will sustain the popularity of buybacks and dividends,”.
President-elect Donald Trump and House Republicans have proposed a one-time tax holiday on repatriated cash as part of their tax reform proposals. US. non-financial companies will have about $1.8 trillion in cash and liquid investments overseas by the end of 2016, according to Moody’s Investors Service.
A tax holiday in 2004 allowed companies to bring back cash at a tax rate of 5%, well below the top 35% corporate tax rate. The Internal Revenue Service estimated that a total of 843 companies brought back $312 billion, led by Pfizer Inc. PFE, -0.19% Merck & Co. MRK, +0.55% Hewlett-Packard Co. HPQ, +0.82% Johnson & Johnson JNJ, -0.31% and International Business Machines Corp. IBM, +1.48%
The top five companies accounted for 28% of the total, or $88 billion. The intention was to use the funds to hire workers and invest in growth. However, a report from the Democratic staff of the Senate Permanent Subcommittee on Investigations published in October 2011 found that many companies used the money for share buybacks and to boost executive pay. The top 15 beneficiaries actually cut more than 20,000 jobs and slowed the pace of spending on research, the survey found.
Apple Inc. AAPL, +0.06% has the most cash outside the U.S. of any domestic company at more than $200 billion. Chief Executive Tim Cook has been vocal about his reluctance to bring that money home as long as it would be subject to one of the highest tax rates in the world. The company has repeatedly borrowed in the bond market to fund returns to shareholders, adding debt to its balance sheet.
Apple’s stock has gained 6.3% year to date, compared with an 8.7% rise in the Dow Jones Industrial Average DJIA, +0.47% and a 7.4% gain in the S&P 500 index SPX, +0.75%
House Republicans have proposed an 8.75% tax on permanently reinvested overseas cash and a 3.5% tax on other untaxed earnings from overseas, and Goldman’s economist Alec Phillips expects that legislation to be passed in the second half of 2017.
“The probability of significant legislative activity has increased as a result of single-party control for the first time since 2010, and Republican single-party control since 2006,” he said in the note.
Todd Castagno, equity strategist at Morgan Stanley, said he believes there will be comprehensive change to tax policy governing international earnings ---not just a one-time tax holiday---by the end of 2017, and it is highly unlikely to provide for “optional repatriation” of overseas earnings.
“We believe the most likely policy outcome is the imposition of a mandatory tax on offshore earnings required to transition to a new system for taxing foreign source income,” Castagno wrote in a note to clients.
Credit analysts believe that returning the bulk of repatriated cash to shareholders could have negative credit implications, but it wouldn’t necessarily be better if current tax policies were kept in place and companies continued to hoard cash overseas.
“The ability to move cash around freely is a positive thing,” said Megan Neuburger, managing director of corporate ratings at Fitch Ratings, as it increases a company’s options regarding the deployment of capital.
For companies like Apple, Microsoft Corp. MSFT, -0.02% and Cisco Systems Inc. CSCO, +0.03% which have raised debt domestically to fund share repurchases, returning repatriated cash to shareholders wouldn’t necessarily be credit negative.
“If they have access to cash balances, they could be less inclined to raise debt in the future,” said Richard Lane, senior analyst at Moody’s.
A few companies on Monday unveiled new stock buyback plans. Constellation Brands Inc. STZ, +1.44% said it is adding another $1 billion to its existing $1 billion program. Citigroup Inc C, -0.02% said it would add up to $1.75 billion to its program, boosting its overall capital action plan to $12.2 billion.
On Friday, Facebook Inc. FB, +0.10% announced plans to buy back up to $6 billion of its stock.
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