U.S. corporations continue to accumulate cash, with the latest data showing that companies were holding $1.79 trillion at the end of last year, up from $1.77 trillion at the end of the third quarter. And it’s not clear whether there’s anything on the horizon that could encourage companies to start putting some of that money to use.
However, U.S. companies are not alone in holding sizable amounts of cash, since the trend is also clear among European companies, according to Anthony Carfang, a partner and director at consultancy Treasury Strategies.
“It’s not as if a couple of corporate treasurers have said, ‘Hey, let’s hoard cash,’” Carfang said during a briefing last month. “Higher cash levels seem to be the way that companies are managing risk and uncertainty,” he said.
In the U.S., corporate cash has held relatively steady as a percentage of GDP, rising from 10% in 2000 to 11% in 2012, Carfang said. In Eurozone countries, the cash holdings of represent a higher portion of GDP, ranging from 14% to 20%, and he said that probably reflects the difficulty that European companies have in pulling their cash into a single pool.
Carfang argued that central banks’ easing efforts are contributing to finance executives’ uncertainty. “CFOs are now saying, ‘There is so much intervention in the markets, we don’t know what the real cost of capital should be, we don’t know what a longer-term investments should be returning to our corporation, and as a result we are not investing the cash,’” he said. “It’s as if the massive amount of intervention has taken away an important market signal back to corporate treasurers.”
In fact, a Treasury Strategies survey of finance executives showed that 44% expect their cash balances to increase over the next six months, up from 35% who expected cash balances to increase last September.
When borrowing became difficult during the financial crisis, many companies found themselves constrained by their lack of “financial flexibility,” said Gregory Milano, CEO of Fortuna Advisors, a strategic advisory firm.
As a result, “a lot of companies now have a different view of how much cash and liquidity they need to have available to run their business and make opportunistic investments when they come along,” Milano said. “People are more conservative and rightfully so, because a lot of them were caught with inadequate liquidity during the financial crisis.”
The piles of cash have led corporations to return more to their shareholders in the form of dividends and stock buybacks. Standard & Poor’s says S&P 500 companies bought back $99.15 billion of their stock during the fourth quarter and paid their shareholders $79.83 billion in dividends.
The fourth-quarter buybacks trailed both the $111.75 billion seen in the third quarter of last year and $118.4 billion in buybacks during the third quarter of 2011. The fourth-quarter dividends total was a record, aided by the special dividends and early payments of first-quarter dividends that companies announced late last year in anticipation of this year’s increase in the tax rate paid on dividends.
The immediate impact from a stock buyback is usually positive, given the confidence the purchases convey, said Milano, pictured at left. But “the evidence in the market is that the companies that heavily buy back stock on average generally don’t do well.”
Dividends work better than buybacks, according to Milano. “The thing about dividends that there is no price risk. If you pay a dividend, you’re just giving money back to shareholders. If you buy back stock at $600 and then it drops to $400, all the people who stuck with you are upset because you paid the people who left $600 a share,” he said.
Of course, holding high levels of cash can also weigh on companies.
“If you’re a fast-growth or a high-return company, you can get away with holding cash,” Milano said. “But if you’re not growing fast or producing a high return, then cash can be a real drag on your share price.”
“Even during the downturn, companies that invested have done better than those who just battened down the hatches,” he said. “We would say that running the cash balance down by investing in the business would be a much better outcome than by buying stock back.”
And while Milano expects buybacks to increase, he doesn’t see that making a significant dent in companies’ piles of cash. “Earnings are at record levels, the cash flow behind that coming out of operations will hit a new record, and although companies are investing more, they’re not investing enough. I don’t see a huge decline in those cash balances,” he said.
Of course, a chunk of companies’ cash is held overseas because companies are reluctant to pay the U.S. tax they would incur by bringing by the funds home. Moody’s recently estimated that 57% of corporate cash was held overseas. It said the fact that so much of the cash was held overseas also reflected the strong performance of many emerging economies in recent years and companies’ use of cash held in the U.S. for dividends and buybacks.
“There’s more cash trapped overseas than ever in history and there’s no obvious solution to that,” Milano said. “I don’t think the current administration really wants to give everyone a tax break to bring it all back.”
But a renewed interest in acquisitions could get companies to put cash to work, including the cash they hold overseas, Milano said, adding that the CEOs and CFOs who are his customers are talking more about acquisitions. “A big burst of M&A and a lot of cash-based deals, international and domestic, could happen,” he said. “Then suddenly we’ll have a lot less cash on people’s books.”
But Treasury Strategies’ Carfang said finance executives are still facing considerable uncertainty on a range of issues, including the outlook for the economy and regulatory changes. “No one knows what’s around the corner here,” he said, but added, “if things were to return to normal, you would see [the ratio of] cash to GDP decline.”
Read the May Special Report on Cash Management & Forecasting.