In the latest edition of BofAML’s closely-watched global fund manager survey (out April 16), respondents indicated a clear preference for de-leveraging when asked about the best use of cash.
Specifically, the percentage of those polled who want corporates to delever was 43%, and while that represented a downtick from the previous month, it’s still within spitting distance of the post-crisis record.
(BofAML)
The percentage who want to see capex increase rose 4ppt from last month, but the figure is still near the lowest since October 2009. Meanwhile, the percentage of respondents expressing a preference for returning cash to shareholders was just 16%, not far from the record low set in February.
In keeping with the apparent preference for improving balance sheets, respondents continued to see corporates as overleveraged. “Concerns about the credit cycle is the primary worry of FMS investors, with 44% saying they think corporate balance sheets are overleveraged, up 3ppt MoM”, BofA’s Michael Hartnett wrote, adding that December and January were record highs.
(BofAML)
All of this is consistent with the notion that, while buybacks have been kind to investors (to say the least), concerns about too much leverage ahead of a possible turn in the cycle are mounting.
But is this just lip service? After all, what would you say if someone asked you what you’d most like to see corporates do with their cash at a time when too much leverage is the topic du jour and the cycle is as long in the tooth as it is? You’d probably say “reduce debt” because, you know, decorum and such.
A quick look at the relative performance of companies who actually have reduced debt versus those who have levered up further over the past 12 months tells a slightly different story.
Goldman analyzed the performance of two baskets, “Debt Reducers” and “Debt Issuers”. Here is how those baskets are constructed:
Both of these baskets are sector-neutral to S&P 500 ex. Financials and Real Estate and consist of the 50 stocks with the highest trailing 12- month net paydown/issuance as a share of starting enterprise value (EV). The median stock in our basket of Debt Reducers paid down debt equal to 5% of enterprise value during the past 12 months while the median debt issuing stock issued debt equal to 7% of EV. The typical S&P 500 stock had no change in debt during this period. Debt Reducers have lower net leverage (net debt/EBITDA) than Debt Issuers (1.4x vs. 2.3x and 1.6x for S&P 500).
You might assume that if everyone is truly concerned about leverage, the equity of companies that worked to reduce debt would at the very least be keeping pace with that of companies who are actually adding leverage late in the cycle. As it turns, out, Goldman’s “Debt Issuers” have outperformed, and by a fairly wide margin.
(Goldman)
“Debt Reducers have underperformed Debt Issuers by 10 pp during the past 12 months (3% vs. 13%) and by 3 pp YTD (16% vs. 19%)”, Goldman writes, adding that “this underperformance is unusual because most ‘quality’ strategies have outperformed during 2018 and into 2019.”
The bank attributes part of this to the way they measure the paydown/issuance ratio (as a share of EV, which skews things towards inexpensive stocks), and in the same note, Goldman makes it clear that “recent market performance indicates a clear investor preference for safe, high quality balance sheets.”
That said, “safe, high quality balance sheets” doesn’t necessarily mean that a company is taking active measures to reduce leverage. So, apparently, fund managers’ express preference for companies that pay down debt should be taken with a grain of salt. A simple read is that if you’ve already got a pristine balance sheet, all the better for you, and if not, don’t worry about trying to improve it, because at least as far as the equity market is concerned, nobody cares.
