A May 5th report from Morgan Stanley European Equity Research argues that corporate buybacks in Europe are likely to start moving up from the current low base given the macro and earnings backdrop and low borrowing costs. They also note that while activism is a small factor, the number of campaigns are soaring and could increase pressure to buyback stock. The report explains the argument and identifies stocks likely to undertake stock buybacks in the next couple of years.
MS analyst Krupa Patel and colleagues note: “We highlight 6 factors that are supportive of a pick-up in corporate share buybacks in Europe: i) Europe’s macro backdrop is improving; ii) European corporate balance sheets remain solid; iii) earnings upgrades have started; iv) dividend payouts are rising;v) record low borrowing costs;and vi) increase in shareholder activism.”
Europe lags U.S. in stock buybacks
Krupa and colleagues point out that the surge in buyback activity in the U.S. over the last year or so has led to a sharp difference between buyback trends in Europe and the U.S. S&P 500 firms bought close to $600 billion stock compared to $100 billion for companies in MSCI Europe. Unlike in the U.S., European firms have not yet taken advantage of ECB easing and ultra-low corporate bonds to initiate buybacks.
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Not just activism – Reasons to expect more buybacks in Europe
1) The MS report highlights that Europe’s macro backdrop is steadily improving. They recently upgraded their GDP growth forecasts for 2015 and 2016 to 2.2%, reflecting stimulus from the easing in financial conditions (lower FX/oil/bond yields), ECB QE and improved credit dynamics. Krupa et al. argue: “This improving economic outlook should be supportive for an increase in buyback activity.”
2) European corporate balance sheets are also looking good. Europe’s net debt to equity ratio has been stable over the last few years as firms have managed balance sheets cautiously. The current ratios suggests that corporate balance sheets are reasonably healthy, especially given the very low cost of debt servicing. Exhibit 2 highlights that Europe’s interest cover is historically high, and this series may move higher still, given the bounce in corporate profits and drop off in corporate bond yields.
3) Krupa and colleagues also note that the earnings upgrade cycle has begun in Europe. European stocks are seeing net earnings upgrades for the first time in four years. They suggest an earnings recovery should add impetus to buyback activity. Exhibit 4 illustrates that 12-month forward EPS growth tends to lead YoY growth in buybacks by a couple of quarters.
4) Dividend payouts are also moving up. The MS anaysts highlight growing dividend momentum and the fact that MSCI Europe’s dividend revisions ratio just moved in to positive territory for the first time in two years. Of note, buyback growth and dividend growth tend to be positively correlated.
5) Record low borrowing costs also make it cheaper for companies to issue debt to finance shareholder-friendly actions. The pace of U.S. stock buybacks has closely tracked both corporate bond issuance and yields for more than 10 years.
6) Shareholder activism has been a growing theme across global equity markets for some time now. Activist Insight notes that the number of firms worldwide that have been the subject of activist campaigns has doubled over the last three years, but Europe has been lagging the global trend. That said, shareholder activism might be starting to pick up in Europe as well, as we have recently seen activist efforts at both Vivendi and AllianceTrust.