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Cash & Working Capital

Capital Allocation: No Easy Matter

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October 31, 2018

By Ted Howard and Julie Zawacki-Lucci

Tax reform has encouraged a lot of companies to revisit their capital allocation plans; meanwhile, many are on the sidelines, waiting for clarity. 

Capital allocation has been a hot topic across NeuGroup peer groups since tax reform was announced at the end of last year. With so much cash coming back onshore, many US multinationals are finding it challenging to determine their optimal capital deployment strategy. Vocal investors may call for stock buybacks, but executives may wonder if the company would be better off earning a return on cash through investments in the business. The problem is deciding how buybacks and investments can be compared and whether the company should instead strengthen the balance sheet by holding excess cash or reducing debt.

Most meeting sessions explored all of these considerations, and in doing so, members heard about how to allocate capital more effectively, in discussions ranging from the theoretical to the specific, supported by peer experiences.

For instance, the treasurer of a major retailer said that a wide-ranging analysis, including internal assessments, white papers and talking with peers, concluded that more emphasis should be put on producing growth. “Comparing our reinvestment rates to best-in-class companies told us we need to invest more if we want to be a higher performer,” he said, adding that those companies committed to targets including cash flow, working capital and cash balance—not just dividend and share repurchases.

At another meeting, one expert in driving shareholder value said companies tend to repurchase shares when their stock prices are high, but research shows that more buybacks don’t necessarily result in higher stock prices. Instead, he suggested, companies should time repurchases for when their shares are on the upswing, noting for example that had Exxon Mobil taken that strategy, it would have bought back 35% more shares for 26% less per share. But it’s easier said than done, one member said. “Please go talk to my activist shareholder, because he’s the reason I can’t keep cash on my balance sheet!”

Capital Allocation Decision Making and Metrics 

Factors Capital Allocation Global Affiliates 

Nudged by Tax Reform? Really?

In a cross-group survey of NeuGroup peer groups, 69% of respondents said they hadn’t changed their plans after tax reform (see middle chart below).

The truth, however, is that many of those in the “no change” camp qualified their answers with an explanation revealing the true answer should be “no, not yet.” That’s because a lot of “nos” said it was because of pending acquisitions and the resulting blackout periods for share repurchases or that they were waiting for more guidance. Therefore, it’s just a matter of time before more companies announce plans to give cash back to shareholders, lest activists start agitating for change. That said, one assistant treasurer at the meeting, echoing the shareholder advisor mentioned above, expressed skepticism that buybacks result in stock price appreciation, or a “pop,” as he put it. Another member said the best approach is not to try to time the market and to adopt a stance of “always be buying today.”

So there is more change in the works. In fact, since the tax overhaul freed up trillions, member companies report being in various stages of repatriation and making changes to capital structure and allocation. An assistant treasurer at a company that has brought back more than $25 billion (and has taken some losses on transferred assets) said treasury is trying to determine “what is the right capital structure going forward, what to do with the cash, what do investors want?” Another member said her company’s capital expenditures rose, but not because of tax reform. But the overhaul meant the company could fund the capex “more easily.” She said the company now is trying to figure out the right cash balance and is finding its banks all “use different metrics” to answer that question. She said her company’s complex entity structure means it takes longer to determine the most efficient way to bring back cash and there’s been no need to bring it all back. A third member said she knows what her company needs to do with the cash: pay down debt. The more problematic issue is the need for cash forecasting, she said. Prior to tax reform, the company ran a large commercial paper program, so cash forecasting was “not a big deal; if I’m within a billion it was comfortable. That is obviously no more.”

Meanwhile, among companies that have changed their capital allocations plans (23%), the plans reveal some practical strategies. For instance, the treasurer of a large tech company in NeuGroup’s Treasurers’ Group of Mega-Caps (tMega) shared with fellow members how his company is approaching its stock buyback plan in the wake of reform and after having repatriated large amounts of cash. The treasurer described the new framework as less prescriptive than the previous approach, which had a specific cadence but had given up some flexibility. But now the company is not announcing when it will execute buybacks. The company’s goal is to “embed flexibility” in timeline parameters, measuring in years, not months or quarters.

Despite the wake-up call from tax reform, it isn’t the only factor pushing treasury to revisit capital structure. Some members in a variety of groups discussed the need to make adjustments to account for changes in their portfolio of businesses, especially companies that are expanding in unregulated businesses while their regulated businesses have strict capital requirements. Some members also cited credit ratings as another important variable.

There is no magic bullet of course, so when it comes to the decision about cash levels and capital allocation, networking with peers can offer valuable insights.

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