Cash to Shareholders Is a Benefit, as Long as You Watch the Debt -- Barrons.com

By Al Root

Debt-fueled buybacks are back. While that can be dangerous for companies with too much leverage, borrowing prudently is one way to turn balance sheet strength into shareholder value.

S&P 500 companies returned some $1.5 trillion to shareholders in 2023, according to Bloomberg, up about 7% from the $1.4 trillion returned in 2022. Dividends accounted for just over 40% of 2023 payouts, a slight increase from 2022, indicating that payouts grew a little faster than buybacks.

Faster payout growth is expected for 2024, with buybacks taking the lead. Desh Peramunetilleke, global head of quantitative strategy at Jefferies, estimates that U.S. dividends will grow by a little more than 6% this year. Separately, Reynolds Strategy founder Brian Reynolds projects that buybacks will grow about 13%. Taken together, investors can expect more than $1.6 trillion in total payouts this year, up about 10% compared with 2023.

Investors like growth, but $1.6 trillion consumes nearly all of the free cash flow expected from S&P 500 companies. That's fine -- in theory. Free cash flow is what's left over after investing in the business. But practically speaking, some of the 2024 payouts will be made by increasing debt. A similar dynamic played out in 2023. To make the math work, nonfinancial companies in the S&P 500 index added more than $140 billion in debt, according to FactSet. Debt to earnings before interest, taxes, depreciation, and amortization, or Ebitda -- a common measure of balance sheet health -- ticked up to about 1.9 times from 1.8 times. Below two times isn't an alarming number.

Within the market, the technology sector is once again the standout. Jefferies' Peramunetilleke believes that payouts will grow faster for technology stocks, while growth for traditional defensive sectors such as utilities and consumer stables will trail. Tech stocks also have the benefit of relatively strong balance sheets. The debt to Ebitda ratio for tech sectors in the S&P 500 is about 0.4 times, well below the nonfinancial average. In fact, if the S&P 500 tech sector borrowed enough money to get to the 1.9 times debt to Ebitda ratio, it would mean another $1 trillion in potential payouts.

Tech companies with the highest shareholder yield -- combining dividends and buybacks -- and lowest debt-to-Ebitda ratios include NetApp, Cisco Systems, and Cognizant Technology Solutions. Their shareholder yields average 5.2%, better than the S&P 500's 3.7% average. None has any debt after deducting cash balances.

United Parcel Service doesn't meet any of those requirements. It isn't a tech company, and its debt-to-Ebitda target is 2.5 times, higher than the S&P 500 but still good enough for an investment-grade rating. But the company has big plans to return cash to shareholders. At a meeting with investors this past week, UPS laid out its capital return plans for the coming three years. It aims to use half of its net income for dividends, and then return the rest of its leftover cash after required investments to shareholders in the form of buybacks.

That's a lot of cash. With the company expected to grow sales by roughly 6% a year through 2026 and operating profits going twice as fast, UPS could return up to $30 billion in cash to shareholders over the coming three years, once additional debt to keep it at its current debt-to-Ebitda target is accounted for. The $10 billion annual average is good enough for a shareholder yield of 8%.

It's a sound capital allocation strategy, but UPS stock didn't react positively to the new goals. Investors are taking a wait-and-see approach, after a difficult 2023 punctuated by contentious labor talks that sent volume to rival logistic networks and produced skepticism about growth targets.

Yes, there's a lot to worry about at UPS, but investors might want to pay more attention to cash payouts. They could boost the stock in the coming years. B

Write to Al Root at allen.root@dowjones.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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March 29, 2024 03:29 ET (07:29 GMT)

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