With companies sporting abnormally high levels of cash these
days, they're feeling greater pressure to give something back to
hike is the normal route, but an increasing number of companies are
initiating massive stock buybacks.
I looked at some intriguing buyback-fueled stock picks
a month ago
and since then, a fresh crop of companies have announced
major stock buyback programs. I've compiled a list of the companies
with the largest buyback programs announced since Thanksgiving. In
the table below are six companies that have announced plans to buy
back at least $1 billion in stock, all of which have the potential
to shrink the share count by at least 5%.
After taking a deep look at all six, here are the two stocks that
appear to have the most upside.
This maker of hard disk-drives aims to show the power that a
massive buyback can bring. If its plans are fully realized, its
share count will be at least 25% lower in a few years. When coupled
with improving industry dynamics, it could turn Seagate into
The $2 billion buyback plans came after the company decided to end
talks about going private. Management says that offers for the
stock (presumably in the mid-teens) were too low. They believe that
concerns about the demise of hard disk drives are overblown, which
was likely a factor in negotiations. Some tech watchers think that
solid state memory drives will replace disk drives in coming years,
but most tech watchers doubt we'll see such a move. Seagate has
proof: demand has started to rebound in recent weeks, leading
management to raise guidance.
Analysts took a look at that raised guidance -- and the massive
share buyback -- and started boosting their ratings and price
targets. Needham seesshares rising from a recent $15 to $19, and
now thinks fiscal (June) 2012
earnings per share (
will hit $2.35 after a likely slump below $1.50 in the current
. Needham declines to factor the stock buyback into itsprofit
forecasts, yet notes that it could add $0.50-$0.75 toEPS in fiscal
2012, and $1.00 toEPS in fiscal 2013. That sets the stage forEPS in
excess of $3 by then.
How will Seagate pay for the buyback? The company will likely use
up half of its current $2 billion gross cash balance and also
announced plans to issue fresh debt. Avian Securities notes that
Seagate should also generate $100 to $200 million in
free cash flow
every quarter. Brean Murray notes that "fiscal 2012 could be an
outstandingEPS growth year even without the share repurchase,"
adding that "if STX were to generate $2 in calendar 2011EPS , this
could push the stock towards $20." That's more than 30% upside from
current levels, andshares have likely limited downside after the
recent boost in guidance and that massive stock buyback.
Do you believe that natural gas prices will eventually move up from
their current multi-year lows? That's the thesis of some investors
that foresee a steady switch to natural gas as a power source for
our nation's truck fleet. After all, some have coined the United
States as "the Saudi Arabia of natural gas." Rising demand could
lead prices to rise from a current $4.25 per million BTUs to $6.
Such a move would create a powerful tailwind for Canada-based
Encana, which has brought in partners to double its production. The
company has already raised $4 billion in the last three years, and
if recent talks with China National Petroleum come to fruition,
another $2 billion could come in the door.
Encana focuses on what's known as "unconventional gas," which means
it pursues potentially massive energy fields that are difficult to
tap unless you're willing to commit a lot of money. And that's what
the company has done, spending an average of $7 billion on capital
expenditures in each of the last five years.
Thanks to those heavy investments, Encana was able to generate
nearly $2 billion in free cash flow (
) in 2009, even as natural gas prices remained weak. That FCF
figure likely slumped in 2010 as the company throttled back
development spending, but the recent cash injections from new
partners means that spending -- and eventually free cash flow --
should start to rebound. And that's emboldened management to start
buying back stock, especially as it sits at levels last seen back
Right now, Encana plans to buy back around 37 millionshares , but
that may just be the beginning. If production surges in 2011 and
2012, as the company suspects, and if natural gas prices can rise
even modestly, then Encana should become a cash machine and future
buybacks could be well larger.
To be sure, Encana has its detractors. "The street continues to
dislike its strategy of growth into a weaker gas market," note
analysts at National Bank Financial. They recently upgradedshares
to "Buy," believing that sentiment toward Encana and other gas
plays is "overly pessimistic." They favor Encana since it "is one
of North America's low-cost producers" and expectshares to rise
from a current $28 to $40, although if natural gas prices start to
rebound in the next 12-18 months, then that price target should
prove to be too conservative.
Action to Take -->
Big buybacks are a company's way of saying "ourshares are too
cheap." In the case of Seagate and Encana, there has been an awful
lot of pessimism around their business models. Their buybacks
signal an outlook that could be higher in 2011 and 2012 than many
currently expect. You'd do well to consider either of these
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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