In recent years, shareholder activists have pushed companies such as Microsoft (MSFT) , Apple (AAPL) and Cisco (CSCO) into returning some of their mountains of cash to shareholders. Because dividends and share buybacks tend to make a stock more attractive, figuring out which companies could be targeted next might be a smart investment strategy.
Bruce Falbaum, principal at investment adviser Cohanzick Management, seeks out situations like these. While he isn't an activist himself, he bets on companies he thinks will realize that their capital isn't being "optimized."
In many cases, he will buy the stock, but at least as often he will short the bonds. That's because Falbaum looks at cash as just one component in what he refers to as "net leverage," a metric that takes into account a company's cash position as well as outstanding debt. The lower the net leverage, the greater the ability to fund buybacks or dividend hikes.
Of course, buying a stock just on the prospect of a dividend or buyback shouldn't be the only consideration. But it's worth taking note of companies with low leverage that might be ready to increase it to pay for dividends or buybacks, either on their own or under pressure from activists.
Here are seven companies Falbaum has targeted. While many of them have already signaled plans to increase dividends or buybacks, Falbaum doesn't believe the moves are fully baked into the stock or bond prices yet. In many instances, he foresees larger dividend hikes or buybacks than the market currently expects.
H&R Block (HRB)
The nation's largest tax preparer also owns a bank, which means regulators can block the company from buying back stock or paying dividends. So H&R Block has been trying to sell the bank. But the company also wants to maintain an investment-grade rating by keeping its leverage down. The cost of lower leverage is fewer buybacks or dividends, but Falbaum sees the investment-grade rating as an unnecessary luxury.
"No one cares that their tax preparer is investment grade vs. high yield," Falbaum says. "If they don't take themselves to high yield I will not be surprised if an activist shows up or an LBO firm shows up and forces them to."
CBS has less leverage than many comparable companies. The broadcasting and entertainment giant already spent $800 million on share repurchases in the last three months of 2014. It also increased its quarterly dividend to 15 cents per share from 12 cents starting in the third quarter.
Falbaum sees potential for far more, however.
"Their cash flow has been significant enough that they have not increased leverage yet, but analysts are fully expecting them to do that this year," Falbaum says.
Pepsi has a $12 billion share repurchase authorization over the next three years. It has already been targeted by Nelson Peltz's Trian Partners, which wants it to split up. Falbaum says Pepsi could afford to buy back from $17 billion to $19 billion worth of shares without significantly increasing its borrowing costs. He also says the company bought some time in its battle with Peltz by appointing former H.J. Heinz CEO Bill Johnson, an adviser to Trian Funds, to its board. Still, he says, "the story's not over."
McDonald's has roughly $3 billion in cash, a relatively small number compared to the other companies on this list. However, it has been issuing debt to buy back shares and raise its dividend, along the lines of proposals by hedge fund manager Bill Ackman of Pershing Square Capital Management. Falbaum is selling short the bonds because he says the company's valuable real estate allows it to take on significantly more debt to fund more shareholder givebacks.
"It's not necessarily that the company is getting that much better; it's just that the capital structure's becoming a lot more efficient," Falbaum says.
Coach shares have severely underperformed the market over the past 12 months, losing more than 17% though they have been an outperformer over the past three months. Falbaum expects the outperformance to continue as he sees significant potential for the company to take on more debt to fuel dividend hikes and buybacks. If Coach doesn't take those steps on its own, an activist or LBO firm may target the company, Falbaum contends in this Hedge Fund Intelligence article.
Coach said on its latest earnings call it would maintain its dividend in 2015. It still had authorization to repurchase $836.7 million worth of shares as of Dec. 7, 2014 but had not bought back any shares for at least six months according to its latest quarterly filing.
Read More: When Must I Buy a Stock to Get the Dividend?
Oracle has $42 billion in cash, cash equivalents and marketable securities, according to its latest quarterly filing with the SEC. It has already been issuing debt to buy back stock, a practice Falbaum expects to continue. He has shorted the bonds on that expectation.
"We are committed to returning value to our shareholders through technical innovation, strategic acquisitions, stock repurchases, prudent use of debt, and the dividend," said CFO Safra Catz on Oracle's latest earnings call.
Qualcomm is a similar story to Oracle. It has roughly $40 billion in cash and marketable securities, according to its latest quarterly filing, and also has been issuing debt to buy back stock.
In its last earnings call, Qualcomm reiterated plans to issue debt during the second quarter as part of a goal CFO George Davis described as "really returning capital more aggressively."
Falbaum has shorted Qualcomm bonds.