Kicking the buyback habit
Retailers and their investors have become addicted to stock repurchases in recent years. But as the economy shows signs of slowing, buybacks may no longer be an option.
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| Home Depot has halted its $22.5 billion buyback program because of the housing slump. |
(Fortune) -- Like holiday shoppers maxing out their credit cards, the nation's retailers have been racking up debt buying back their own stock. Now their bills are coming due.
As the economy slows and consumers curtail spending, large retailers are struggling to meet their buyback commitments. Home Depot (Charts, Fortune 500) and Macy's (Charts, Fortune 500) recently said they planned to postpone or scale back share repurchases, and analysts expect other retailers to issue similar warnings in the months ahead.
"Retailers have been quick to drink the Kool-Aid of stock buybacks, and now they are paying the price," said Charles O'Shea of Moody's Investors Service.
While buybacks have been hugely popular across industries in recent years, they've been especially beloved by large retail firms. Retailers generate tons of cash, but are slow-growing and have fewer opportunities to invest that money in acquisitions or store expansions. Stock repurchases have become an easy way to placate investors (by reducing the number of shares outstanding, which bolsters earnings per share).
So far this year, retailers have accounted for nearly 28 percent, or $122 billion, of the record $443 billion in buybacks either announced or completed, according to data tracker Capital IQ.
Now, with the odds of a U.S. recession increasing, a buyback hangover looms, which is bad news for retailers and investors alike. As companies like Home Depot, Macy's and Kohl's issued debt to buyback company stock, their credit quality declined. That's never a good position to be in when the economy sours.
Already, there are early signs of a buyback slowdown. Cheered several months ago by investors for announcing a $22.5 billion buyback plan, Home Depot has temporarily halted its repurchasing in the face of a deteriorating housing market.
"Home Depot is the poster child for [the buyback binge]," said O'Shea, the Moody's analyst.
Macy's is also stepping on the buyback brakes. The department store retailer said it would slow the pace of buybacks, which totaled $3 billion so far this year, because of concerns over the tightening credit markets.
Gap is another retailer whose repurchase program could be at risk. The struggling retailer has been relying on cost cuts and share buybacks to bolster earnings. Gap (Charts, Fortune 500) spent $887 million in the third quarter to repurchase 48 million shares, and has plans to buy back $613 million more. While the company hasn't said yet whether it plans to follow through on its buyback plan, the extra money might come in handy if the company's turnaround strategy falters and the economy weakens.
"Companies are going to want to think twice about using cash for share repurchases when they may need it next quarter to fund operations," said Tiffany Co, an analyst with Fitch Ratings.
Two more clues that buybacks could soon be out of fashion: In 2000, when the Internet bubble burst and the economy went into a temporary tailspin, the value of buybacks announced that year plunged, according to Capital IQ. During the Southern California supermarket strike in 2003-2004, Safeway and Kroger both reduced share repurchases and instead used that cash to invest in their businesses, according to Co.
No one is suggesting that retail buybacks will come to a complete standstill. Many retail stocks are trading at 52-week-lows, providing a compelling argument for companies to buy back shares at historically low prices. What's more, companies that have used buybacks to increase earnings in recent quarters may find it difficult to kick the habit.
Several major retailers have recently announced large buybacks. Target (Charts, Fortune 500), which is under pressure from activist investor William Ackman, said it would repurchase $10 billion shares over three years. The news put a dent in Target's pristine credit rating, which Fitch, the ratings agency, lowered a notch to A from A+.
"Once a company has done a big buyback, the pressure is on to keep doing more," said Carol Levenson of Gimme Credit, an independent bond research firm.
If the economy continues to slow, investors' tolerance for higher debt is likely to lessen even more. "Retailers should be husbanding their assets so that they have financial flexibility heading into this fairly uncertain holiday shopping season," warned Henderson, the Moody's analyst.
Halting a buyback program is far easier than lowering a dividend or postponing capital expenditures, which tend to be planned far enough in advance to weather economic downturns. All of which leads some analysts to predict that retail buybacks could go the way of prairie skirts and find themselves temporarily out of style. 
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