Yesterday in a post about Caterpillar (CAT Scratch Fever) I highlighted the company’s strategy to manufacture earnings growth despite 2 consecutive annual sales declines (2014 sales are expect to be down 16% from 2012’s peak):
Earlier this year the company completed a $1.7 billion accelerated buyback and after the companies Q2 revenue miss, and subsequent decline announced another accelerated share repurchase (ASR) this time to the tune of $2.5 billion.
I guess desperate times call for desperate measures. How could you argue with the strategy, the Fed is practically begging investors of all shapes and sizes to go balls long equities?? At the end of Q3 2014, CAT will have bought back $4.2 billion of stock (current market cap about $68 billion), so despite what analysts expect to to be a 9% earnings increase in 2014, net income is only expected to be up 2.5%. In the 5th year of an economic recovery, this activity seems fairly mental to me.
In a post back on July 1st (How Important Are Stock Buybacks?), Enis looked at earnings and sales growth for the S&P500 for the last 3 years and concluded:
According to Bloomberg, sales have grown about 14% over the past 3 years for the S&P 500 index, while earnings grown about 25%….Meanwhile, the S&P 500 has appreciated about 55%, as multiple expansion has been a bigger driver than earnings growth for the move higher in stocks)…..In other words, EPS growth has outpaced sales growth by about 11% during the past 3 years
Profit margins have been relatively flat over the past 3 years, increasing about 0.5% in that period. That 0.5% increase in margins would lead to a 5% incremental increase in earnings based on sales per share in the S&P 500 around 1120 at the moment. The other 5-6% increase in EPS over the past 3 years is due to buybacks and other factors (like lower taxes).
In sum, buybacks have likely contributed about 5% of the 25% growth in Earnings Per Share in the S&P 500 index over the past 5 years, or about 20% of the total growth in EPS.
And lastly, let’s look at everyone’s favorite, Apple (AAPL). The universal tenet of the BULL case for Apple is that the stock is cheap. Hard to dispute that relative to the broad market, and most of its history on a P/E basis. I would note that trading at about 15.5x fiscal 2014 earnings it is at almost the exact same multiple it was when the stock last traded this level in Sept 2012:
So while earnings are expected to be just about the same for fiscal 2014 (concludes at the end of Sept) as they were in fiscal 2012, the company has grown sales from $156 billion to about $180 billion, or by about 15%, while gross margins are expected to be down about 5 points in that time period and net income is expected to decline from $41.7 billion in fiscal 2012 to about $38.9 billion this year (6.7% decline). But the company is a cash machine as cash flow per share is expected to increase from 7.77 in 2012 to 9.29 in 2014. So what to do? Buyback a ton of stock and pay more dividends. Well they have done that, to the tune of probably about $55 billion in share repurchases and more than $15 billion in dividends since since 2012. Given the fact that AAPL likely has two thirds of their $165 billion of their cash on their balance sheet the company has had to raise debt to help fund their aggressive cash return policies.
So this is all fine and good, fairly reasonable balance sheet management, but the question I would ask for the not too distant future is this, at some point will AAPL’s current portfolio of very hot products may not be so hot, and profitability of existing products is likely to continue to wane….how do they create an entirely new category AND a suite of services to help maintain their industry leading profitability? At some point in the very near future will AAPL face the inevitable fact that their hardware margins will be unsustainable as lower end competitors compete the only way they know how, on price.
I obviously have no clue, taking management at face value they seem VERY confident about the future product portfolio. But it is my sense that financial engineering will remain a key driver in the Apple story. This will likely buoy the shares for some time to come, but I would be less confident in company’s like CAT who have stepped up their buyback at multi-year highs. Apple will be bought on dips by the company aggressively, and by shareholders, CAT will need to see a whole host of things to go right for the story to keep working without real hard earnings and sales growth.