By Al Root
Not all capital-return strategies are created equal.
Steel maker Cleveland-Cliffs reported first-quarter earnings on Monday. Bottom-line earnings missed estimates by a few cents a share, and the stock dropped 11%. That wasn't the biggest reason for the drop, though.
The company spent some $600 million repurchasing 30.4 million shares in the first quarter, amounting to about 6% of the total stock outstanding. It also announced an additional $1.5 billion repurchase authorization. It had stopped paying a quarterly dividend during the pandemic.
Investors typically cheer large capital returns, whether they be buybacks or dividends. The problem is that Wall Street projects a 2024 free cash flow for the company of about $530 million, and $770 million for 2025 -- and those numbers don't support its buybacks.
To make up the difference, Cleveland-Cliffs -- whose bid to buy United States Steel was spurned -- will take on more debt. "We are implementing a more shareholder-friendly leverage target of 2.5 times net debt to last 12 months adjusted Ebitda, allowing ourselves even more flexibility for aggressive shareholder returns," Chief Financial Officer Celso Goncalves said on Tuesday. (Ebitda is short for earnings before interest, taxes, depreciation, and amortization.)
Net debt to Ebitda is a common measure of balance sheet strength. Cliffs' ratio at the end of the first quarter was about 2.3 times. Dividend payers in the S&P 500 index have an average ratio of about 1.9 times.
"We are surprised [by] the scale of the buybacks, having (incorrectly) assumed that balance sheet flexibility would be the No. 1 priority until the M&A backdrop was fully resolved," Citigroup analyst Alexander Hacking wrote.
The postearnings stock drop wiped out about $1 billion in market value from Cleveland-Cliffs. That is very close to the debt needed to fund the new buyback.
Capital return to shareholders is great, but investors don't like robbing Peter to pay Paul.
Investors are about two weeks away from getting the answer to the question: Will 3M remain a Dividend Aristocrat? While investors wait, there are better Aristocrats to consider.
The industrial/chemical conglomerate has raised its dividend for 64 consecutive years. To qualify as an Aristocrat, companies must have raised dividends for at least 25 consecutive years.
There are 67 Aristocrats in the S&P 500, including 3M, which is facing cash outflows related to legal liabilities that threaten its balance sheet and the dividend. Only one of 19 analysts covering the stock, or about 5%, rates the shares Buy. The average analyst price target implies a gain of about 6% from current levels.
The average Buy rating ratio for the 67 Aristocrats is 47%, and the upside based on average price targets is about 9%. Nine of the 67 have Buy-rating ratios above 70%: S&P Global, Walmart, Emerson Electric, NextEra Energy, Becton Dickinson, Coca-Cola, McDonald's, Abbott Laboratories, and Dover.
Their average Buy-rating ratio is about 80%, and the average upside to analyst price targets is about 14%.
The nine most popular Aristocrats yield about 2%, below the 2.6% average for the 67 Aristocrats and well below the 6.6% yield 3M shares currently offer.
Still, it isn't always a good idea to chase the highest dividend yields. The more popular stocks look like the better bet. Their total return for the coming 12 months implied by yields and analyst price targets is about 16%, better than a comparable 10% return for the less-popular Aristocrats and a 13% return for 3M.
Investors should stick with the Aristocrats Wall Street likes best.
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.
(END) Dow Jones Newswires
April 25, 2024 02:30 ET (06:30 GMT)
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