3 Stocks That Could Benefit From Buybacks
MINNEAPOLIS (Stockpickr) -- Large companies are starting to take matters into their own hands. With stock valuations low and interest rates at record lows, it is a virtual no-brainer for any large company to issue debt, the proceeds of which can be used to buy back stock.
Leading the way is
Microsoft
(MSFT) - Get Report
. In mid-September, the software behemoth took advantage of a cheap debt market by issuing three-year debt with a coupon of 0.875%. At the same time, the company announced that it would begin a buyback of stock worth up to $40 billion.
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Are you kidding me? Who wouldn't issue debt at that rate?
The ramifications of the financial crisis and deflation fears in the U.S. may just set the stage for the biggest issuance of debt in some time. For Microsoft, it was the first time the company has made such a move.
Hewlett-Packard
(HPQ) - Get Report
announced in early September that it would boost its $4.9 billion stock buyback by $10 billion. Helping to pay for that bold move will be the proceeds collected from a $3 billion bond issuance. To the extent that HP completes the buyback program, its total shares outstanding will decrease by 14%.
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All of this is very good news for investors, especially those who have seen large company stocks lag the huge gains made in small company stocks. In my opinion, the news from both Microsoft and HP signals a trend that is likely to be followed by other large companies.
Think of it as an arbitrage play, and those executives playing the game clearly believe that their stocks are undervalued relative to debt markets. Investors should take a cue by following other large companies will look to duplicate the program.
Here are
three names that are prime candidates for debt-issuance-fueled stock buybacks
.
Chevron
The oil companies operated in anonymity for most of 2010. With oil prices comfortably below the $150-per-barrel peak price, the spotlight was on other concerns. Aside from the big oil spill in the Gulf of Mexico, the oil industry went mostly unnoticed during the year.
Don't feel so bad. The industry prefers the lack of attention, and it certainly did not suffer last year. Oil companies print money. It is one of the easiest ways to make money. With a product that is in such high demand and limited supply, there is only one direction for prices.
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As long as prices do not go too high, oil companies such as
Chevron
(CVX) - Get Report
can sit back and collect the cash. OPEC has done a fantastic job managing supply so as to control price, so the risk of prices going too high is slim. Except for the little blip two years ago, oil prices have been fairly well-contained. As such, it is smooth sailing for Chevron and other oil companies.
With some $13 billion in cash on its balance sheet, one would assume that buying back stock is a reasonable option. That option becomes more likely if you consider the opportunity to issue debt at record low rates.
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It is an arbitrage opportunity. The stock trades for 10 times trailing earnings and 8.4 times forward earnings. Putting two and two together, it's easy to conclude that Chevron is a candidate for a big buyback program.
3M
The falling dollar is doing wonders for the export business of
3M
(MMM) - Get Report
. The large conglomerate is a leader in selling to foreign markets, and those sales have made the company one of the biggest in the land.
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The problem for 3M and many other large companies is to find legitimate uses of cash. It is very difficult to find opportunities that can provide a reasonable return on capital. The solution is to buy other companies or buy back stock.
Here, too, the arbitrage story is in play. One could make the case that management is dropping the ball if it does not take advantage of a once-in-a-lifetime debt market to sell bonds.
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It's not like 3M stock is expensive. Shares trade for 15 times trailing earnings and 13 times forward earnings. At the moment, there is plenty of growth to support the current valuation and beyond. Management should recognize that fact and put together a nice fat buyback package.
Coca-Cola
The prerequisite for large companies buying back stock goes beyond the arbitrage play. To the extent that a company has massive amounts of cash flow and diminishing opportunity to invest that cash, the alternative is to buy back stock.
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Management could certainly use that cash to pay dividends, but the better alternative at the moment is to buy back stock. For
Coke
(KO) - Get Report
, the company is making money hand over fist. The margins in selling soft drinks and other beverages are huge.
What else can the company do with that cash?
Add in the rocket fuel of low debt levels, and the result is too obvious to elaborate. Coke trades for a reasonable 19 times trailing earnings, but only 16 times forward earnings. The stock is cheap. It should buy back stock with some of the $13 billion in cash on hand, and if it so chooses, it can issue debt to really make a statement.
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Fore more potential buyback plays, check out my
portfolio.
-- Written by Jamie Dlugosch in Minneapolis.
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At the time of publication, author had no positions in stocks mentioned. Jamie Dlugosch is a founder and contributor to
MainStreet Investor
and
MainStreet Accredited Investor
. Formerly, he was president and CEO of Al Frank Asset Management. He has contributed editorially to
The Rational Investor
,
The Prudent Speculator
,
Penny Stock Winners
and
InvestorPlace Media
.
Dlugosch is the editor of Penny Stock Winners. He has over 20 years of experience in financial markets including investment banking, equity analysis and research and money management. In addition to being the Editor of Penny Stock Winners, he is also a Contributing Editor of InvestorPlace.com and founder and editor of The Rational Investor.
