You already know that US corporates have been saving their retained earnings as cash this year, while the IG-bond rally has been driven increasingly by companies taking advantage of the debt-equity arb.
In other words, the one thing non-financial corporates have not been doing with their cash is spending it on labour and capital.
Moody’s has a paper out this week that quantifies these trends. A few highlights:
The balance sheets of U.S. non-financial companies are in good shape, in contrast to government and household balance sheets. Some $943 billion of cash and short-term investments sat in their coffers at mid-year 2010, compared with $775 billion at the end of 2008 (Figure 1). Corporate America could use these cash holdings to cover a year’s worth of capital spending and dividends and still have $121 billion left over.
Economists, politicians and everyday Americans contemplate how that cash, if invested in inventory and plants, could strengthen the U.S. economy and get more people back to work. But we believe companies are looking for greater certainty about the economy and signs of a permanent increase in sales before they let go of their cash hoards, which they suffered so much to build. Given low demand and capacity utilization within certain industries, companies are wary of investing their cash in new capacity and adding workers, thereby doing little to abbreviate the jobless recovery. It also does not help that much of the cash, perhaps one-fourth, is located offshore and unlikely to be repatriated to the U.S.
And unfortunately, Moody’s predicts that even if things get better, companies will be slow to expand, choosing other things to do with their stash:
The cash provides U.S. companies safety come rain or shine. In the event of a relapse in the U.S. economy, the cash will buffer the downturn. If the economy gradually improves, we expect more companies to begin buying back shares as it is hard to justify to shareholders ever-increasing cash balances that yield a less than 1% return. We also think that mergers and acquisitions will be a more probable use of cash over the next couple years. With low interest rates and generally low company valuations, we expect companies will seek to consolidate their market positions or add complementary businesses.
Moody’s adds that the cash-hoarding is being led by the tech sector ($207bn), pharma ($124bn), energy ($105bn), and consumer products ($101bn).
As to the decline in capital expenditure, here are two charts that illustrate the point:
The ratio of cash to capital expenditures in the 12 months to the end of Q2 was 1.64, the highest that Moody’s has on record. As of December 2008, the ratio was 1.1 per cent.
But let’s turn our attention to a different chart, which shows that companies have been reducing their debt-to-cash ratios:
If history is any guide, then the “excessive” borrowing spanning 2005-2008 will take some time to repair. Spanning 2002 to 2004, the non-financial business sector dropped leverage 2.5% to 64%. If this 2-year period of de-leveraging indicates an “equilibrium” level of leverage, then non-financial businesses are likely to run consecutive financial surpluses (excess saving) in order to reduce debt levels by another 11 percentage points of GDP for a decade more.
So in normal times, it would seem strange that companies with plenty of cash, seeking to reduce their leverage, would be tapping debt markets to such an extent anyway. But obviously, these aren’t normal times.
Moody’s notes that companies have more than enough cash to fund quite a lot of spending, including acquisitions, and to cover dividend payments without having to resort to debt markets. Yet many companies have done just that. Moody’s again:
Much of the debt-issuance proceeds have been used to refinance existing debt, but some has been stockpiled for broadly termed general corporate purposes. At mid-year 2010, the aggregate cash-to-debt ratio was 0.28, materially better than the 0.23 at December 2008. While we hear a lot about the looming debt refinancing cliff, receptive bond markets and generation of operating cash flow are combining to make the cliff look less intimidating for the stronger, higher-rated companies.
Sure, bond markets are receptive now, especially to the “stronger, higher-rated companies”. But as it’s Halloween, we’ll close by asking again whether the extraordinary interest rate environment in which we find ourselves is just postponing the inevitable for weaker companies — in other words, zombies!