The CFO of United Airlines presented at the Morgan Stanley 12th Annual Laguna Conference on Thursday and he tipped his hand that the airline is about to start buying back stock.
I do want to get United on a path to two times net debt to EBITDAR. I think that’s the right level of leverage longer term. But the pace at which we get to that level of leverage will be consistent, will be paced by what our equity multiple is.
And at four times, I think that pace to two times leverage will be a little bit slower. So you need to stay tuned on a shareholder capital allocation. But we have checked off all the boxes that are priorities before we were to announce a buyback.
It seems likely that CEO Scott Kirby will ask the United board to authorize a multi-billion dollar share buyback at the next full meeting, which should allow for an announcement with third quarter earnings in about a month.
Investors frequently think that buybacks are a lot better than they are, while the median voter thinks they’re far worse than the reality.
- Of course buybacks should be permitted. Surely you don’t think a company should only be allowed to increase the number of shares outstanding, and never reduce them?
- But buybacks don’t enrich shareholders. It’s simple math, and people who think otherwise are economically illiterate. If you do a $1 billion buyback, you reduce the number of outstanding shares buy you also reduce the amount of money the company has by $1 billion. It’s a break-even transaction.
And by the way, the cash held by the company already belongs to the shareholders. It is in the company’s account. The company distributes the cash. The company is worth less, moving the cash from its balance sheet over to shareholders (who invest it elsewhere).
- Buybacks mean a business has limited opportunity for profitable growth. They have cash that they cannot employ productively in the business, so they can sit on it or return it to shareholders. By the way, that’s a strong signal in many cases that company management sees limited future prospects for growth. That’s not great for stock price!
- So buybacks are good for society. It is better to transfer assets from low return businesses, back to shareholders, to invest in higher social return opportunities. That’s good for the economy and society.
- Buybacks don’t usually raise the price of stock in a materially lasting way. Share price includes the cash held by the company. When they distribute the cash the airline has a lower value, because they have less cash. They also have fewer shares. Stock buybacks literally cannot make shareholders wealthier.
- It’s just like a dividend. Stock buybacks return cash to shareholders. They’re effectively a more tax-efficient form of dividend (since there’s no income tax if you don’t sell your shares into the buyback). Yet no one seems to complain about dividends even though they’re basically the same thing.
Stock buybacks are tax-efficient dividends, moving cash from low productivity investments (the company doesn’t have better uses for the cash to generate returns in excess of their cost of capital) to higher productivity ones.
Of course, companies can make strategic errors in doing buybacks.
- American Airlines was buying back stock in the $50s, buying high and selling low, issuing new shares during the pandemic at a fraction of what they bought shares for – and now those shares are worth less than $11.
- And American was effectively borrowing money to fund those buybacks – and their borrowing costs are a continued drag on performance.
Sometimes buybacks bump share prices briefly. And there’s a common belief that companies orchestrate their timing to coincide with pre-planned insider stock sales, in conjunction with a 10b5-1 plan. That might be bad! But it’s a narrow concern that’s not fully demonstrated empirically in the data.
What is a fair concern is – as Delta CEO Ed Bastian has said, that there’s a government put on airline stocks now – that the government will always be there with bailouts if needed. And if that’s the case, the government is subsidizing bailouts, and perhaps if the government’s implicit guarantee of airlines is real then they should be required to keep higher minimum levels of cash so that taxpayers avoid being on the hook.
Better would be to remove any such implicit guarantee – the only way to do that would be to allow the bankruptcy process to wipe out an airline’s equity when the time comes, redistributing gates and aircraft and pilots to stronger employers (letting, say, American Airlines and Spirit go bankrupt, and thus permitting Delta and Frontier to grow, as well as allowing new entrants into the market – including foreign carriers).
Airlines were precluded from doing stock buybacks after taking government bailouts during the pandemic. It would have been unseemly to use taxpayer money to fund them. But those restrictions are gone and United would like to signal that they are strong, and will continue to be strong, so they don’t need the war chest. They’ve been performing well, but not for a long period of time, and the U.S. could enter recession – making the time a risky one to start unloading billions of dollars in corporate cash.
The reason Kirby wants to do stock buybacks is because UAL as a company is worth just 55% of what DAL is worth and the relationship has not changed in quite some time.
UAL has alot of cash on hand – they intended to use it to buy their massive amounts of new airplanes but those airplanes are not coming.
UAL wants to reset the value of the company relative to their competitors. they could pay a dividend but the size of DAL’s dividend doesn’t justify its much higher stock price.
DAL is said it is much more interested in refleeting and further debt reduction before it thinks about any capital return strategies.
and it should also be noted that sitting on a bunch of stock is not great if corporate raiders come circling
Agree it is net break even as company resources are used for the purchase. However it does give the message to shareholders that the stock is undervalued which is typically a positive indication. Also, since number of shares are reduced the future earnings per share increase and PE ration goes down which historically has been a positive for the stock.
Personally I love it when a company whose stock I own does a buy back. Of course there is a difference in a high growth company w little debt and a highly leveraged airline. I’d probably rather see UA use the funds to deleverage or grow revenue generating businesses.
I am not a shareholder of UA or any other airline since I feel they are suboptimal long term investment so I really don’t care what they do.
So they believe that their temporary terminal in IAD is not worth investing it, that their ancient and split-operations terminals in ORD are not worth investing in, and they prefer to give away their cash.
We all remember what Tim Clark of Emirates said about stock buy-back.
In many if not most cases, stock “buybacks” are not reducing the total number of shares, but rather taking shares out of public circulation and putting them into the company’s treasury.
The “benefits” to the existing stockholder is illusory at best.
Very often the shares subject to the “buybacks” are used as non-cash executive compensation in the form of RSUs (restricted stock units) or for low cost stock options for executives. In this way, executives can have boosted compensation in a form that isn’t so obvious to the rank-and-file employees (including union members) who are subject to much lower or non-existent salary or wage boosts.
This is a very common trick employed by high tech companies.
In the end, this buys nothing for the shareholders other than a short term perception.
@Tim Dunn – stock buybacks aren’t going to make UAL stock worth as much as DAL
Their FAs are going to be PISSED that they are telling Wall Street that they essentially have cash to spare. I’m surprised they are sending this signal prior to wrapping up negotiations with AFA.
Gary,
theoretically, you are just dividing the pie differently but stock buybacks have the potential to increase share price and can increase market cap is the increase in share price is high enough.
I will grant you that it has rarely worked in the airline industry and it certainly didn’t at American.
That said, I still think there is a certain fear at UAL that they have too much cash on hand and they are not performing at levels comparable to DAL which does expose them to activist risk. UA has unlocked alot of its potential but there clearly is a whole lot more than could be done. Sitting on that much cash and generating 60% of DAL’s profits last year could be enticing to some raiders.
It is also worth noting that Delta has long kept its cash balances fairly low and had credit lines to draw down as needed.
United has an enormous amount of things they could spend money on but I suspect they are realizing that all of these terminal projects aren’t going to bear fruit esp. if their aircraft deliveries are much lower than they planned – which is likely.
@tim dunn – “stock buybacks have the potential to increase share price and can increase market cap is the increase in share price is high enough.”
the empirical data just doesn’t support this happening in any meaningful way or sustained period of time, and not just in the airline industry
i’m not saying they shouldn’t do buybacks, as I write clearly I am defending the notion of buybacks, just explaining they are often misunderstood. if they don’t have good uses for the cash, it should be returned to shareholders.
UAL should buy back all its stock and disappear up its own orifice.
Stock buybacks tell me that the EO can’t think of any better ways to reinvest cash flow to improve their business. Symptom of a loser EO.
I have seen a lot of companies doing stock buybacks later have cashflow problems. I am never enthusiastic about stock buybacks. I consider it the same as blood letting by a witchdoctor.
Meanwhile, Kirby continues to hold out on contract negotiations for his employees, while he greedily pockets MILLIONS!
Gary,
obviously ALL of the data doesn’t support your conclusion or buybacks wouldn’t happen at ALL.
There is all kinds of research done including in business but most of it is inconclusive and a heck of a lot less biased that your conclusions about a whole lot of things are.
If there was conclusive evidence that stock buybacks didn’t ever work, they wouldn’t happen.
Business, as with life, involves a certain amount of chance and alot of execs play roulette with someone else’s money thinking they will win.
United very well could succeed in getting a higher market cap and a better relation to Delta stock than they have now.
and they might not.
but don’t you dare say that there is conclusive evidence that Kirby’s plan won’t succeed.
Gary, all your arguments about how positive stock buybacks are fade considerably when you remember that American was bailed out by the taxpayer after they spent billions buying a $10 stock for $50 dollars a share.
Of course he wants the cash out the door. I was talking to former airline/aircraft OEM exec and his point to me was that there will always be another catastrophe (9/11, covid, ?). The govt bailouts don’t come if you have the cash to survive. It makes sense to have a balance sheet weak enough to survive. I agree with the author, airlines should have to maintain substantial cash positions to bake in the bail-out exposure or just be allowed to fail.
It’s ridiculous that I can buy a car from the Germans or the Japanese but I can’t fly Lufthansa or ANA from LA to Chicago. (I sound fancy. We all know I’d be flying Viva Aerobus.)
I mean this is a surprise to literally no analyst in the industry and isn’t even the first time the CFO has talked about this, on the last earnings call Mike said “You’re going to see the free cash flow returning to shareholders” – this can only be achieved in 2 ways… dividends or buybacks and one is more tax efficient and does not set a regular precedent that a company is then marked against in future years (thus making it a better way to return capital particularly for companies with inconsistent earnings like airlines). Gary why are you posting this this as new news?
@Tim I know you’re a delta lover, got any insights on why UAL is spinning off much more cash than DL recently, even with UAL investing more for growth with a higher capex bill and higher debt it seems surprising to me.
Stock buybacks keep private equity from taking a position in a company with the thought that they can extract value from the company by selling assets. Private equity is the reason companies prefer to not have equity in the company. For airlines, this means leasing airplanes instead of buying them, and if they buy them, they get a large loan. If Southwest didn’t have equity in airplanes, gates, and other equipment, they would not have been interesting to private equity. In this sense, AA doesn’t have to worry about private equity acquiring them. They have no investments to sell.
Stock buybacks also prevent the stock option awards from devaluing the existing stocks. But, buying back stock is really about keeping the net value of the company from being substantially positive to keep private equity away. And I say this with a close relative in private equity.
You missed a reason for buybacks is that it allows the company to give shares to employees, especially the C-suite.
Buybacks make sense when there is reason to believe that the stock is undervalued, whether they have inside info as such or just trying to signal. But also as you say companies do this when they have nothing better to do with the cash…and airlines are rather restricted, they can’t just start a new division in a new industry to seek growth. So buybacks if stock undervalued are pretty much the only option for airlines, and certainly better than blowing a few hundred million launching new routes with a low chance of success.
andy,
UAL is not generating more cash than DAL other than in a few quarters; they took out alot of debt during covid and have not repaid the cash because they expected to use it for aircraft purchases.
Now that Boeing cannot and will not deliver the number of airplanes that UAL has contracted, United management is deciding that having that much cash on hand is dangerous when corporate raiders are playing in the airline industry.
And don’t forget that United has not settled with its flight attendants. when they do, their earnings will fall by hundreds of millions of dollars per year and they will use a half billion dollars of that cash for retro – if UAL settles for anything like American.
and United’s earnings are much more cyclical quarter to quarter than Delta’s so settling for an even larger amount w/ the FAs means UA’s earnings will fall even more and retro payments will increase.
You might want to fix the typo in the point about calling people illiterate, just saying.
Also, I’m not sure that I agree with you the buybacks break even. I take your point that the business has to pay money to get the shares in the first place. But after the buyback, the smaller share of stockholders each get a proportionally bigger slice of the pie. Which means an entitlement to a larger portion of future earnings. I’m not really expressing a moral position either way on this, but I do think it isn’t quite right to suggest that buybacks have a purely net zero effect. The company is tying up its cash assets to give stockholders each a larger proportion of its earnings.
@ John H – I agree…too much cash on hand is just like potential food for the vultures.
But, I think it was Warren Buffet that said “cash is a buffer against unforeseen events”. AA’s buybacks were stupid. They destroyed their Balance Sheet in doing so. When Covid hit, they had the least flexibillity of the Big Four.
If they have excess cash though, they could buy some planes with cash. At least Kirby is framing in the light of what he want’s the Debt/Equity ratio to be versus just saying he wants to “enhance shareholder value”.
How about finishing the contract negotiations with your Mechanics and Flight Attendants before giving money back to the shareholders?
This just shows how low a priority labor is to these executives.