Saturday, March 17, 2012

The advantage of the large cap quality stock

Businessweek (and others) published a piece on the Coca-Cola bond offering that spoke to (1) the pace and size of debt being issued recently; and (2) strong investor interest resulting in extremely low absolute and relative yields.  The FT sums it up:
"Investors wrestling with a low yield environment are opting for the safety of owning company debt backed by solid balance sheets. That explains why companies such as McDonalds, IBM, Walt Disney and Procter & Gamble have sold paper at record low yields this year."
Large cap quality stocks (defined loosely as profitable, modestly leveraged, dividend paying large multi-nationals) are in a position to borrow very cheaply relative to the Treasury and LIBOR yield curves, and very cheaply on an absolute basis. 

As an example, Microsoft's 4% Feb 2021 bond has a yield of 2.39% which is only 10bps above the benchmark 10 yr US Treasury (source: TRACE).  To compare the absolute level against something, a quick number to grab is the EBITDA/EnterpriseValue of about 12.72% (source for all data is Yahoo! Finance unless otherwise stated).  

The obvious advantages of  raising debt is the cash to invest in efficiencies, growth, other companies, and their own stock.  Furthermore, these are not bad stocks to own right now in a variety of scenarios.  For example... 
  • If we continue to see an environment of slow, but positive, U.S. growth in a zero-to-low rate environment due to continued uncertainty about  jobs, housing, the Euopean debt crisis, and political brinksmanship: then we continue to enjoy a healthy dividend (2.4% in the Microsoft example) and benefit from any stock buybacks.
  • If conditions result in another recession: then we continue to enjoy the dividend (assuming it is not the end of the world... again) and some relative downside protection vs other more growthy stocks and more volatile risk assets.
  • If economic conditions improve: then we may expect to enjoy not only stock buybacks but dividend hikes as earnings grow--and companies will have stockpiled cheap cash to deploy for that growth.
What are your thoughts on these stocks?

Disclosure: long position in Microsoft

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