Add Jim Chanos’ to the number of voices worried that American companies are running out of gas and in need of real consumer demand to create revenue.
In an interview with Bloomberg’s Masters in Business, hosted by Barry Ritholtz, Chanos explained how corporate buybacks were less a sign of strength and more a cry for help from American companies.
He said: “What worries me is that corporate America in aggregate, has pre-tax returns on capital in the mid to high teens. The long-term expected rate of the equity markets, is roughly half that. And when corporations embarked on massive buybacks across all industries and all companies, in effect these CEOs are buying the stock market. So what they’re telling you then, is unequivocally that they think that either they’re happy to earn the stock market rate of return or maybe something hopefully better. Or their rate of return on the margin of any new capital project is much much lower, in fact half or less of what is stated. And that does not bode well for the future of profits, or for the quality of earnings reported as current profits.“
The point is that there will come a time when companies won’t be able to hide their lack of revenue growth with share buybacks or other handy tools.
Barclays’ U.S. equity strategist Jonathan Glionna wrote about this last week, and he also pointed out that what these companies really need is not accounting hoodoo, but rather it’s the almighty American consumer.
“We believe U.S. equities are transitioning out of a recovery rally and into a period of lower returns as the benefits of margin expansion and share repurchases prove to be already priced in and a return of faster revenue growth becomes a prerequisite for another re-rating higher,” he wrote.
That faster revenue growth was supposed to come from the purchasing power of the American consumer.
Ideally — as in some ideas we had back in 2008 and 2009 — by this time, this all-encompassing market force was supposed to have bounced back from the recession and started spending money again.
But it hasn’t.
U.S. Retail sales growth has crept down from May’s 0.4% to June’s 0.2% to July’s flat growth. As Business Insider’s Sam Ro pointed out, it was the worst retail sales number in six months.
Last week Wal-Mart lowered its guidance for the third quarter and revised down full-year earnings to $US4.90 to $US5.15 per share from previous guidance of $US5.10 to $US5.45.
According to FactSet, for 63 companies have issued negative earnings per share guidance and 26 companies have issued positive earnings per share guidance for the third quarter of 2014. In other words, not even American companies think they can pull it out in this environment.
Check out the chart below:
So there will be no rescue from the American consumer, at least not right now.
All of this makes for a risky environment in the meantime, especially as corporate cash flows remain high but flat (more on this here).
To please shareholders, companies still have to figure out how to keep stock prices afloat. That could mean buying more stock while prices are high — which should not please shareholders — or it could mean going another route.
Chanos says that corporate balance sheets are looking healthier because analysts aren’t deducting acquisitions from a company’s cash flow as they should.
“Increasingly we’re seeing acquisitions, which are not taken out of most analysts for cash flow numbers, acquisition are replacing CapEx or R&D,” Chanos said. “So companies are buying their R&D or their capital, and that should [be] properly deducted from cash flow, because in aggregate corporate America is not growing. So by buying each other and buying divisions of each other, in effect, they’re capitalising their R&D … and that particularly applies for big tech, which are perceived as very cheap companies. If you actually look at them, the only reason their revenues aren’t declining at a reasonable rate is because they’re buying other companies.”
So what we have here is a race against time. If you buy all this, the stock market needs the American consumer to come back soon to prevent some serious selling — earnings are not what they seem.
We’ve stopped growing.
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